# Finance

Topics: Bond, Debt, Money Pages: 38 (1252 words) Published: January 26, 2013
Chapter
8
Bond
Valuations

Bond
Value
=
PV
of
coupons
+
PV
of
par
Bond
Value
=
PV
annuity
+
PV
of
lump
sum
As
interest
rates
increase,
bond
prices
decrease
and
vice
versa
Interest
Rate
Risk

The
risk
arises
for
bond
owners
from
fluctuating
interest
rate,
depending
on
how
sensitive
its
price
to
interest
rate
changes
(factors:
maturity
time,
coupon)
• The
longer
the
maturity
&
the
lower
the
coupon
rate,
the
greater
interest
rate;
10-­‐year
bond
much
more
interest
rate
risk
than
1-­‐year,
but
only
slightly
less
than
the
30-­‐year
bond
(Time-­‐lock-­‐in)
• For
two
bonds
with
same
time
to
maturity
but
different
coupon
rates,
lower
coupon
bond’s
value
depends
more
on
the
face
value
to
get
at
the
end,
and
when
interest
rate
fluctuate,
the
prices
moves
around
(Coupon-­‐lock-­‐in)
• For
coupon
being
higher,
large
cash
flows
are
in
early
years
and
less
sensitive
to
later
interest
rate
changes
1.
Pure
discount
bond

2.
Level
coupon
bond

Yield
to
maturity:
market
interest
rate
for
bond
with
similar
features
(par
etc); the
yield
to
maturity
(YTM)
of
a
bond
is
the
discount
rate
that
makes
the
present
value
equal
to
the
current
bond
price;
opportunity
cost
of
capital
Annual
effective
rate:
???
How
to
value
a
discount
bond
with
annual
coupons?
• N
=
5;
I/Y
=
11
(YTM);
PMT
=
100
(coupon
pay);
FV
=
1000;
CPT
PV
=
-­‐963.04

• YTM
with
Semiannual
Coupon:
P/Y=2;N
=
40;
PV
=
-­‐1197.93;
PMT
=
50;
FV
=
1000;
CPT
I/Y
=
8%
Interest
rate
and
bond
prices
Discount:
coupon
rate<
market
rate
(to
build
up
the
interest
to
the
market
value
is
only
to
decrease
the
selling
price,
known
as
“built-­‐in-­‐gains”;
We
must
not
be
offering
a
high
of
rate
as
comparable
bonds
(equal
risk).
Therefore,
we
know
current
rates
are
HIGHER.)
coupon
rate>
market
rate
(We
must