FIN 4303 CHAPTER 5 CONTENT
CHAPTER 5
BOND PRICES AND INTEREST RATE RISK
CHAPTER OBJECTIVES
1. The purpose of this chapter is to begin to explain how interest rate movements affect the prices of assets and liabilities of investors and financial institutions. The two chapters that follow pursue this same objective.
2. When finished with this chapter the student should understand the mechanics of bond valuation and the simultaneous determination of prices and yields in financial markets. In addition to fixed income bonds, zero coupon bond and amortized loan concepts are presented.
3. The reader will study several yield concepts, including yield to maturity, holding period or realized yield, and expected yields with simulated future values.
4. The concept of interest rate risk is developed, including bond volatility concepts, price risk, and reinvestment risk. A bond volatility measure for price risk is developed.
5. The reader will study duration concepts as a measure of a) bond volatility and b) a holding time period sufficient to balance price and reinvestment risk assuring the investor the yield to maturity.
CHANGES FROM THE LAST EDITION
1. The expanded theme of risk management is extended in this revision. Duration is introduced as a measure of interest rate risk. Duration is a proxy for the price volatility of a bond, given a change in interest rates.
2. Number Thirteen end-of-chapter question has been deleted.
CHAPTER KEY POINTS
1. In the first section time value of money concepts are reviewed briefly. These concepts are assumed for the rest of the chapter, so understanding these concepts are very important. Use of financial calculators are highly recommended for this chapter. Be sure to emphasize the simultaneous determination of price and yield in financial markets and, most important, the inverse relationship.
2. The value of price of a security or loan is the present value of a stream of
BOND PRICES AND INTEREST RATE RISK
CHAPTER OBJECTIVES
1. The purpose of this chapter is to begin to explain how interest rate movements affect the prices of assets and liabilities of investors and financial institutions. The two chapters that follow pursue this same objective.
2. When finished with this chapter the student should understand the mechanics of bond valuation and the simultaneous determination of prices and yields in financial markets. In addition to fixed income bonds, zero coupon bond and amortized loan concepts are presented.
3. The reader will study several yield concepts, including yield to maturity, holding period or realized yield, and expected yields with simulated future values.
4. The concept of interest rate risk is developed, including bond volatility concepts, price risk, and reinvestment risk. A bond volatility measure for price risk is developed.
5. The reader will study duration concepts as a measure of a) bond volatility and b) a holding time period sufficient to balance price and reinvestment risk assuring the investor the yield to maturity.
CHANGES FROM THE LAST EDITION
1. The expanded theme of risk management is extended in this revision. Duration is introduced as a measure of interest rate risk. Duration is a proxy for the price volatility of a bond, given a change in interest rates.
2. Number Thirteen end-of-chapter question has been deleted.
CHAPTER KEY POINTS
1. In the first section time value of money concepts are reviewed briefly. These concepts are assumed for the rest of the chapter, so understanding these concepts are very important. Use of financial calculators are highly recommended for this chapter. Be sure to emphasize the simultaneous determination of price and yield in financial markets and, most important, the inverse relationship.
2. The value of price of a security or loan is the present value of a stream of