Principles of Bond Pricing

CSC Webinar Series Principles of Bond Pricing
CSC Webinar Series

Principles
CSI Global Education Inc.
Principles
of
Bond Pricing
Duration: 60 minutes
Agenda
1. Presentation and reflective questions
2. Questions and answers
Audio Mode: Mic & Speakers
2
Presenter
Scott Boniferro
CFP, FMA
CFP, FMA
3
Purpose
The purpose of this webinar is to help you develop a
better understanding of:
principles of bond pricing, and;
4
principles of bond pricing, and;
how to calculate price and yield on a bond.
A Common Scenario
Issuer Coupon Maturity Price Yield
X 5.5% 10 years 107.98 4.5%
Im looking at these two bonds:
A client says:

5
X 5.5% 10 years 107.98 4.5%
Y 4.5% 5 years 95.67 5.5%
Im leaning toward purchasing Bond X
because its coupon rate is higher.
As my financial advisor,
which bond would you recommend?

Webinar Topics
Bond Price
Calculating the price of a bond
How changes in interest rates affect bond prices
Yield
Calculating the yield on a bond
6
Bond Price
7
What is Bond Price?
The price at which someone is willing to buy or sell a
particular bond on the secondary market.
It is quoted relative to a base value of 100.
8
The price at which someone is willing to buy or sell a
particular bond on the secondary market.
It is quoted relative to a base value of 100.
What is Bond Price?
9
Quoted Price Trading at:
102 Premium
100 Par
98 Discount
What is Bond Price?
102
P
r
i
c
e
10
Maturity
100
98
P
r
i
c
e
Example
Bond A is trading at a premium to par.
11
A 5.5% 5 102.19 5.0%
Question
12
Calculating the Price of a Bond
13
Steps for Manual Calculation:
1. Choose a discount rate
2. Calculate the present value of the principal
3. Calculate the present value of the income stream
14
3. Calculate the present value of the income stream
4. Add the amounts from steps 2 and 3
Formula for Manual Calculation:
Bond Price = PV of the Principal + PV of the Income Stream
1
15
+ C
Principal
(1 + r)
n
r
1 -
(1 + r)
n
1
=
Issuer Coupon Maturity Price Par Value Yield
Example:
16
C 6% 8 ? $1000 5.25%
What would you pay today to invest in Bond C that
offers you a guaranteed sum of $1,000 in eight
years?
Would you pay $1,000 for it today?
C 6% 8 ? $1000 5.25%
17
Step 1: Choose a discount rate
(The yield is the discount rate.)
C 6% 8 ? $1000 5.25%
18
Step 2: Calculate PV of the Principal
Principal
Discount Rate
Compounding Periods
Principal
(1 + r)
n
=
C 6% 8 ? $1000 5.25%
19
Principal
Discount Rate
Compounding Periods
$1,000
C 6% 8 ? $1000 5.25%
20
Principal
Discount Rate
Compounding Periods
Semi-annual
5.25% 2 = 2.625%
C 6% 8 ? $1000 5.25%
21
Principal
Discount Rate
Compounding Periods
8 2 = 16
C 6% 8 ? $1000 5.25%
22
= $1,000 (1 + 2.625%)
16
= $1,000 (1.02625)
16
= $1,000 1.5137
= $660.6329
Calculation
Principal
(1 + r)
n
=
C 6% 8 ? $1000 5.25%
23
Step 3: Calculate PV of the Income Stream
Coupon Rate
Coupon Payment
Compounding Periods
Discount Rate
= C
r
1 -
(1 + r)
n
1
C 6% 8 ? $1000 5.25%
24
Coupon Rate
Coupon Payment
Compounding Periods
Discount Rate
6% 2 = 3%
C 6% 8 ? $1000 5.25%
25
Coupon Rate
Coupon Payment
Compounding Periods
Discount Rate
$1,000 3% = $30
C 6% 8 ? $1000 5.25%
26
Coupon Rate
Coupon Payment
Compounding Periods
Discount Rate
8 2 = 16
C 6% 8 ? $1000 5.25%
27
Coupon Rate
Coupon Payment
Compounding Periods
Discount Rate
Semi-annual
5.25% 2 = 2.625%
C 6% 8 ? $1000 5.25%
28
Calculation
$387.8671 (12.9289) 30
0.026255
0.3394
30
0.02625
(1.02625)
1
- 1
30
16
= =
=
= C
r
1 -
(1 + r)
n
1
C 6% 8 ? $1000 5.25%
29
Step 4: Add the amounts from steps 2 and 3
C 6% 8 ? $1000 5.25%
Formula:
Bond Price =
PV of the Principal + PV of the Income Stream
660.6329 + 387.8671
30
C 6% 8 $1048.50 $1000 5.25%
31
1048.4999
Formula:
Bond Price =
PV of the Principal + PV of the Income Stream
660.6329 + 387.8671
Revisiting the Steps for Manual Calculation:
1. Choose a discount rate
2. Calculate the present value of the principal
3. Calculate the present value of the income
32
3. Calculate the present value of the income
stream
4. Add the amounts from steps 2 and 3
Calculating the Price of a
Bond using a Financial
Calculator
FV I/Y PMT PV N
Calculator Keys
33
FV I/Y PMT PV N
N FV I/Y PV PMT
Calculator
FV I/Y PMT PV N
Calculator Keys
34
Number of payments
or years
N FV I/Y PV PMT
FV I/Y PMT PV N
Calculator
FV I/Y PMT PV N
Calculator Keys
35
Future value
N FV I/Y PV PMT
FV I/Y PMT PV N
Calculator
FV I/Y PMT PV N
Calculator Keys
36
Interest rate
N FV I/Y PV PMT
FV I/Y PMT PV N
Calculator
FV I/Y PMT PV N
Calculator Keys
37
Coupon payment
N FV I/Y PV PMT
FV I/Y PMT PV N
Calculator
FV I/Y PMT PV N
Calculator Keys
38
Present value
N FV I/Y PV PMT
FV I/Y PMT PV N
Calculator
FV I/Y PMT PV N
Calculator Keys
39
N FV I/Y PV PMT
FV I/Y PMT PV N
C 6% 8 ? $1000 5.25%
Calculating the Price of a Bond using a
Financial Calculator
40
C 6% 8 ? $1000 5.25%
I/Y FV PV PMT N
C 6% 8 ? $1000 5.25%
41
C 6% 8 ? $1000 5.25%
8 2 = 16
I/Y FV PV PMT N
C 6% 8 ? $1000 5.25%
42
C 6% 8 ? $1000 5.25%
$1,000
I/Y FV PV PMT N
C 6% 8 ? $1000 5.25%
43
C 6% 8 ? $1000 5.25%
5.25% 2 = 2.625%
I/Y FV PV PMT N
C 6% 8 ? $1000 5.25%
44
C 6% 8 ? $1000 5.25%
(6% 1,000) 2 = $30
I/Y FV PV PMT N
C 6% 8 $1048.48 $1000 5.25%
45
C 6% 8 $1048.48 $1000 5.25%
- $1,048.48
I/Y FV PV PMT N
Relationship between Bond Prices and
Market Interest Rates
Market
Interest Rates
46
Interest Rates
Bond
Prices
Type your questions in the Questions window
Hit the Send button
What questions do you have?
47
Yield
48
What is Yield?
Yield is the rate of return an investor can expect to
receive on a bond.
49
Why is Yield Important?
Yield is used to compare bonds that have similar
characteristics.
50
Example
C 6% 8 1048.499 $1000 5.25%
51
Types of Yield
Yield-to-Maturity Current Yield
52
Types of Yield
The current yield:
53
is the income return on the investment, and
considers only coupon income and current price.
Types of Yield
The yield-to-maturity:
54
is the total income on investment, and
assumes bond income is reinvested and compounded.
Difference between Coupon and Yield
C 6% 8 1048.499 $1000 5.25%
55
C 6% 8 1048.499 $1000 5.25%
Fixed for the term of the
bond.
Coupon
56
C 6% 8 1048.499 $1000 5.25%
Fixed for the term of the
bond.
Yield Coupon
Can fluctuate due to
changes in:
Market interest rates
Market conditions
57
Question
Calculating the Yield on a Bond
59
Formula for Manual Calculation:
Interest income Annual price change
(Purchase price + 100) 2
=
x 100
60
Steps for Manual Calculation:
1. Calculate interest income
2. Calculate the annual price change
3. Calculate the average bond price
4. Calculate the yield-to-maturity
61
Example:
D 5.5% 5 $1021.90 $1000 ?
62
D 5.5% 5 $1021.90 $1000 ?
What is the yield on Bond D?
D 5.5% 5 $1021.90 $1000 ?
63
Calculate interest income
Calculate annual price change
Calculate average bond price
Calculate yield-to-maturity
D 5.5% 5 $1021.90 $1000 ?
64
= $1,000 5.5%
= $1,000 0.055
= $55.00
D 5.5% 5 $1021.90 $1000 ?
65
Price change
= $1,000 $1,021.90
= 21.90
Annual price change
= 21.90 5
= 4.38
D 5.5% 5 $1021.90 $1000 ?
66
= ($1,021.90 + $1,000) 2
= $2,021.90 2
= $1,010.95
D 5.5% 5 $1021.90 $1000 5.01%
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= (55-4.38) 1,010.95 100
= 50.62 1,010.95 100
= 5.0072
= 5.01%
Revisiting the Step for Manual Calculation:
1. Calculate interest income
2. Calculate the annual price change
3. Calculate the average bond price
68
Calculating the Yield on a
Calculator
FV PV PMT I/Y N
Same Calculator Keys
69
FV PV PMT I/Y N
N FV I/Y PV PMT
D 5.5% 5 $1021.90 $1000 ?
Calculating the Yield on a Bond using a
70
PV FV I/Y PMT N
D 5.5% 5 $1021.90 $1000 ?
71
5 years
PV FV I/Y PMT N
D 5.5% 5 $1021.90 $1000 ?
72
$1,000
PV FV I/Y PMT N
D 5.5% 5 $1021.90 $1000 ?
73
- $1,021.90
PV FV I/Y PMT N
D 5.5% 5 $1021.90 $1000 ?
74
$55 (5.5% 1,000)
PV FV I/Y PMT N
D 5.5% 5 $1021.90 $1000 ?
75
4.9924% or 4.99%
PV FV I/Y PMT N
D 5.5% 5 $1021.90 $1000 4.99%
76
4.9924%
PV FV I/Y PMT N
Summary
77
Bonds can trade at a discount, a premium or at par.
Bonds always mature at their par value.
When interest rates go up, bond prices go down, and
vice versa.
Summary: Key Learning
78
vice versa.
Yield is a measure of the return on a bond.
Yield is used when comparing similar bonds.
Yield-to-maturity shows the total return on the bond
between now and maturity.
Summary: Revisiting the client scenario
X 5.5% 10 years 107.98 4.5%
A client says:

79
X 5.5% 10 years 107.98 4.5%
Y 4.5% 5 years 95.67 5.5%

X 5.5% 10 years 107.98 4.5%
A client says:

80
X 5.5% 10 years 107.98 4.5%
Y 4.5% 5 years 95.67 5.5%

X 5.5% 10 years 107.98 4.5%
A client says:

81
X 5.5% 10 years 107.98 4.5%
Y 4.5% 5 years 95.67 5.5%

Bond Price
Calculating the price of a bond
Summary: Topics covered today
82
Yield
Calculating the yield on a bond
Type your questions in the Questions window
Hit the Send button
What questions do you have?
83
All the best!
84

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Principles of Bond Pricing

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CSC Webinar Series Principles of Bond Pricing

CSC Webinar Series

CSC Webinar Series Principles of Bond Pricing

CSC Webinar Series Principles of Bond Pricing

CSC Webinar Series Principles of Bond Pricing

CSC Webinar Series Principles of Bond Pricing

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