7-0 Interest Rates and Bond Valuation Chapter 7 Copyright © 2013 by The McGraw-Hill Companies, Inc....
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Transcript of 7-0 Interest Rates and Bond Valuation Chapter 7 Copyright © 2013 by The McGraw-Hill Companies, Inc....
7-1
Interest Rates and Bond Valuation
Chapter 7
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter Outline
• Bond Definitions
• Bond Valuation
• Interest Rate Risk
• Bond Features
• Types of Bonds
• Bond Markets & Reporting in the Press
• Interest Rates & Inflation
• Term Structure of Interest Rates 2
Bond Definitions• Bond (=IOU)
• Par value (face value)
• Coupon rate
• Coupon payment
• Maturity
• Yield to maturity
• Bond Price
• Current Yield 3
Bond Valuation
• Bond Price = PV of coupons + PV of face• Bond Price = PV annuity + PV of simple CF
• On the financial calculator use TVM keys: face value (F) = FVcoupon payment (C) = PMT, time to maturity (t) = N, yield to maturity (r) = I/Yprice = PV (the PV has the opposite sign of FV & PMT)
t
t
r)(1
F
rr)(1
1-1
C Price Bond
4
Bond Valuation Example 1
A bond has a $1,000 face value and makes annual coupon payments. If the coupon rate is 10% per year, the time to maturity is 5 years and the yield to maturity is 11% (EAR), what is the price of the bond?
5
Bond Valuation Example 2
A bond has a $1,000 face value and makes semi-annual coupon payments. The coupon rate is 8% per year (APR), the time to maturity is 10 years and the annual yield to maturity is 10%, compounded semi-annually. Calculate the price of the bond.
6
Bond Valuation Example 3
Assume a bond makes annual payments and has as a $1,000 face value. The coupon rate is 8% per year, the time to maturity is 10 years, and the bond sells currently for $945. What is the implied yield to maturity?
7
Bond Valuation Example 4
What is the price of a 10-year, zero coupon bond that pays $1,000 at maturity if the YTM is 9% (assume annual compounding).
8
Interest Rate Risk
Definition: Change in price due to changes in interest rates.
- As interest rates increase, bond prices , and vice versa.
- Premium Bond:- Discount Bond:- Time to maturity is related to
interest rate risk.- The coupon rate is related to
interest rate risk .
Bond Features• 3 Main differences between debt and
equity:1.
2.
3.
• Indenture: Contract between the company and the bondholders– basic terms of the bonds– amount issued– collateral– seniority– repayment provisions– call provisions– protective covenants
Types of Bonds• Government Bonds • Zero Coupon Bonds
• Floating Rate Bonds
• Income Bonds
• Convertible Bonds
• Put Bonds
• TIPS (Treasury Inflation Protected Securities)11
Bond Markets & Reporting in the Press
• Primarily OTC • Large, non-transparent market• Bond quotes are available online (
www.bondsonline.com, www.finra.org)• Corporate Bond Quote example (as of 3/2006):
Current ESTName Coupon Maturity Price Yield YTM Spread UST Vol.AT&T (T) 6.25 Mar 15, 2011 102.613 6.09 5.64 68 5 51,936
• Treasury Bond Quote example (5/2006):Coupon Maturity Bid Asked Change Asked Yield8.00 Nov 21 128:07 128:08 5 5.30
12
Interest Rates & Inflation
• The Fisher Effect defines the relationship between real rates, nominal rates and inflation
• (1 + R) = (1 + r)(1 + h), whereR = nominal rater = real rate h = expected inflation rate
• ApproximationR ≈ r + h
13
Interest Rates & Inflation: Example
• Investors require a real return of 15%. Assume an inflation rate of 4%. What is the nominal rate?
14
Term Structure of Interest Rates
• Term structure is the relationship between time to maturity and yields, all else equal
• Yield curve – graphical representation of the term structure
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