chapter 14
DESCRIPTION
Chapter 14. Bond Prices and Yields. Bond Characteristics. Face or par value Coupon rate Zero coupon bond Compounding and payments Accrued Interest Indenture. Different Issuers of Bonds. U.S. Treasury Notes and Bonds Corporations Municipalities - PowerPoint PPT PresentationTRANSCRIPT
Irwin/McGraw-Hill
14-14-11 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Bond PricesBond Pricesandand
YieldsYields
Chapter 14Chapter 14
Irwin/McGraw-Hill
14-14-22 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Face or par value Coupon rate
- Zero coupon bond Compounding and payments
- Accrued Interest Indenture
Bond CharacteristicsBond Characteristics
Irwin/McGraw-Hill
14-14-33 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Different Issuers of BondsDifferent Issuers of Bonds
U.S. Treasury
- Notes and Bonds Corporations Municipalities International Governments and Corporations Innovative Bonds
- Indexed Bonds
- Floaters and Reverse Floaters
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Secured or unsecured Call provision Convertible provision Put provision (putable bonds) Floating rate bonds Sinking funds
Provisions of BondsProvisions of Bonds
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
Bodie Kane Marcus
Rating companies- Moody’s Investor Service
- Standard & Poor’s
- Duff and Phelps
- Fitch
Rating Categories- Investment grade
- Speculative grade
Default Risk and RatingsDefault Risk and Ratings
Irwin/McGraw-Hill
14-14-66 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
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Coverage ratios Leverage ratios Liquidity ratios Profitability ratios Cash flow to debt
Factors Used by Rating CompaniesFactors Used by Rating Companies
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Sinking funds Subordination of future debt Dividend restrictions Collateral
Protection Against DefaultProtection Against Default
Irwin/McGraw-Hill
14-14-88 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
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)1()1(1 rParValue
rCP T
T
T
tt
tB
PB = Price of the bond
Ct = interest or coupon payments
T = number of periods to maturity
y = semi-annual discount rate or the semi-annual yield to maturity
Bond PricingBond Pricing
Irwin/McGraw-Hill
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t=1+
20
= P B 40 1(1+.03) t 1000 1
(1+.03) 20
Ct = 40 (SA)P = 1000T = 20 periodsr = 3% (SA)
PB = $1,148.77
Solving for Price: 10-yr, 8% Coupon Solving for Price: 10-yr, 8% Coupon Bond, Face = $1,000Bond, Face = $1,000
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Prices and Yields (required rates of return) have an inverse relationship
When yields get very high the value of the bond will be very low
When yields approach zero, the value of the bond approaches the sum of the cash flows
Bond Prices and YieldsBond Prices and Yields
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Price
Yield
Prices and Coupon RatesPrices and Coupon Rates
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Yield to MaturityYield to Maturity
Interest rate that makes the present value of the bond’s payments equal to its price
Solve the bond formula for r
)1()1(1 rParValue
rCP T
T
T
tt
tB
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Yield to Maturity ExampleYield to Maturity Example
)1(1000
)1(35950
20
1 rrT
tt
10 yr Maturity Coupon Rate = 7%
Price = $950
Solve for r = semiannual rate r = 3.8635%
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Yield MeasuresYield Measures
Bond Equivalent Yield
7.72% = 3.86% x 2
Effective Annual Yield
(1.0386)2 - 1 = 7.88%
Current Yield
Annual Interest / Market Price
$70 / $950 = 7.37 %
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Realized Yield versus YTMRealized Yield versus YTM
Reinvestment Assumptions Holding Period Return
- Changes in rates affects returns
- Reinvestment of coupon payments
- Change in price of the bond
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Holding-Period Return: Holding-Period Return: Single PeriodSingle Period
HPR = [ I + ( P0 - P1 )] / P0
where
I = interest payment
P1 = price in one period
P0 = purchase price
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Holding-Period ExampleHolding-Period Example
CR = 8% YTM = 8% N=10 years
Semiannual Compounding P0 = $1000
In six months the rate falls to 7%
P1 = $1068.55
HPR = [40 + ( 1068.55 - 1000)] / 1000
HPR = 10.85% (semiannual)
Irwin/McGraw-Hill
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INVESTMENTSFourth Edition
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Holding-Period Return: MultiperiodHolding-Period Return: Multiperiod
Requires actual calculation of reinvestment income
Solve for the Internal Rate of Return using the following:- Future Value: sales price + future value of
coupons
- Investment: purchase price