Finance

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 had 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