Chapter 3 Valuing Bonds · 2019. 10. 9. · Valuing Bonds Principles of Corporate Finance by...
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ACF-203 Fundamentals of Financial Management Chapter 3 Valuing Bonds Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, Franklin Allen. 12th edition. 2017. Joerg Wild Ph.D. CFA FRM Fundamentals of Financial Management Chapter 3 Valuing Bonds J. Wild, PhD CFA FRM 2 Overview 3-1 Using the Present Value Formula to Value Bonds 3-2 How Bond Prices Vary with Interest Rates 3-3 The Term Structure of Interest Rates 3-4 Explaining the Term Structure 3-5 Real and Nominal Rates of Interest 3-6 The Risk of Default Fundamentals of Financial Management J. Wild, PhD CFA FRM 3 Annual compounding (everywhere but in the U.S.). French government bonds, known as OATs, pay interest and principal in euros (€). Suppose that in October 2014 you decide to buy €100 face value of the 4.25% OAT maturing in October 2018. 3-1 Using the Present Value Formula to Value Bonds Chapter 3 Valuing Bonds Calculate the coupon payment (=annual interest payment). State the cash flows in each year. Fundamentals of Financial Management J. Wild, PhD CFA FRM 4 3-1 Using the Present Value Formula to Value Bonds Chapter 3 Valuing Bonds Calculate the PV, i.e. price of the bond assuming a current rate (discount rate) of 0.15%. Conduct the same calculation using the annuity formula.
Transcript of Chapter 3 Valuing Bonds · 2019. 10. 9. · Valuing Bonds Principles of Corporate Finance by...
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ACF-203 Fundamentals of Financial Management
Chapter 3Valuing Bonds
Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, Franklin Allen. 12th edition. 2017.
Joerg Wild Ph.D. CFA FRM
Fundamentals of Financial Management
Chapter 3Valuing Bonds
J. Wild, PhD CFA FRM 2
Overview
3-1 Using the Present Value Formula to Value Bonds
3-2 How Bond Prices Vary with Interest Rates
3-3 The Term Structure of Interest Rates
3-4 Explaining the Term Structure
3-5 Real and Nominal Rates of Interest
3-6 The Risk of Default
Fundamentals of Financial Management
J. Wild, PhD CFA FRM 3
Annual compounding (everywhere but in the U.S.). French government bonds, known as OATs, pay interest and principal in euros (€). Suppose that in October 2014 you decide to buy €100 face value of the 4.25% OAT maturing in October 2018.
3-1 Using the Present Value Formula to Value Bonds
Chapter 3Valuing Bonds
Calculate the coupon payment (=annual interest payment).
State the cash flows in each year.
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3-1 Using the Present Value Formula to Value Bonds
Chapter 3Valuing Bonds
Calculate the PV, i.e. price of the bond assuming a current rate (discount rate) of 0.15%.
Conduct the same calculation using the annuity formula.
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3-1 Using the Present Value Formula to Value Bonds
Chapter 3Valuing Bonds
State the calculation of the yield to maturity (YTM).
Calculate the YTM using your financial calculator.
N= I/Y= PV= PMT= FV=
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3-1 Using the Present Value Formula to Value Bonds
Chapter 3Valuing Bonds
Distinguish between bonds trading at a premium and at a discount.
Calculate the current yield.
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Semiannual compounding for bonds in the U.S. (m=2)
3-1 Using the Present Value Formula to Value Bonds
Chapter 3Valuing Bonds
U.S. government bonds: Treasury bonds: 10 years < t ≤ 30 yearsTreasury notes: 1 year < t ≤ 10 yearsTreasury bills: t ≤ 1 year
Treasury bond quotes, November 2014.
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3-1 Using the Present Value Formula to Value Bonds
Chapter 3Valuing Bonds
Calculate the coupon:
State the cash flows and calculate the PV:
Example: Calculate the price of a 10-year treasury note in 2014 that matures in 2017.
Calculate the YTM using your financial calculator:
N= I/Y= PV= PMT= FV=
Is the bond is currently sold at a discount or premium?
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3-2 How Bond Prices Vary with Interest Rates
Chapter 3Valuing Bonds
The interest rate on 10-year U.S. Treasury bonds.
Recall from your macroeconomics course: What is the relationship between interest rate and inflation?
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3-2 How Bond Prices Vary with Interest Rates
Chapter 3Valuing Bonds
Plot of bond prices as a function of the interest rate. The price of long-term bonds is more sensitive to changes in the interest rate than is theprice of short-term bonds.
What is the relationship between bond price and interest rate?
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Chapter 3Valuing Bonds
A comparison of the cash flows and prices of two Treasuries. Price is calculated assuming annual coupon payments and a yield to maturity of 4%.
3-2 How Bond Prices Vary with Interest Rates
The effect of a 1% fall in yield on the prices of two seven-year Treasuries.
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Chapter 3Valuing Bonds
A comparison of the cash flows and prices of two Treasuries. Price is calculated assuming annual coupon payments and a yield to maturity of 4%. Example:
3-2 How Bond Prices Vary with Interest Rates Duration or Macaulay duration predict the exposure of each bond’s price to fluctuations in interest rates. It is the weighted average of the times to each of the cash payments.
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Chapter 3Valuing Bonds
3-2 How Bond Prices Vary with Interest Rates Modified duration or volatility measures the percentage change in bond price for a 1 percentage-point change in yield.
Calculate the modified duration of previous bond:
Check that prediction. Suppose the yield to maturity either increases or declines by .5%:
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3-3 The Term Structure of Interest Rates
Chapter 3Valuing Bonds
The relationship between maturity and interest rates of government bonds is called the term structure of interest rates.
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3-3 The Term Structure of Interest Rates
Chapter 3Valuing Bonds
Deriving the yield curve: Start by extracting spot rates from treasury strips. Calculate the bond price, then extract the yield.
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3-3 The Term Structure of Interest Rates
Chapter 3Valuing Bonds
Recall: The relationship between short- and long-term interest rates is called the term structure of interest rates.
Short- and long-term interest rates do not always move in parallel. Between September 1992 and April 2000 U.S. short-term rates rose sharply while long-term rates declined. Treasury bond yields.
Yield curve inversion:A yield curve that displays higher yields in the short term then in long term is called inverted.
• Why is this important?
• Potential sign of a recession?
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3-5 Real and Nominal Rates of Interest
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US inflation from 1900 - 2010
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3-5 Real and Nominal Rates of Interest
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Average rates of inflation in 19 countries from 1900–2014.
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Calculate the FV of a $1,000 investment that yields a 10% nominal return.
3-5 Real and Nominal Rates of Interest
Chapter 3Valuing Bonds
Calculate the FV of the same investment assuming an expected inflation rate of 6%. How much is the real rate of return?
State the Fisher equation and its approximation.
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3-6 The Risk of Default
Chapter 3Valuing Bonds
Prices and yields of a sample of corporate bonds. Notice that the bonds all mature in 2017, but their yields to maturity differ dramatically. Why?
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3-6 The Risk of Default
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3-6 The Risk of Default
Chapter 3Valuing Bonds
Yield spreads between two types of corporate bonds (Aaaand Baa rated) and 10-year Treasury bonds.
Are riskless assets, government bonds really riskless?
