1

Valuing Bonds
2
Bond Features

Coupon payments are the stated interest
payments. Payment is constant and payable every
year or half-year.
Face value (par value) is the principal amount
repayable at the end of the term.
Coupon rate is the annual coupon divided by the
face value of a bond.
Maturity is the specified date at which the principal
amount is payable.
3
Bond Value
( )
( )
t
r
F

r
t
r /
C

+
+
|
.
|

\
|
+
=
+ =
1
1 1 1
value face of PV payments coupon of PV V
4
Example 1Bond Value
A bond with a face value of $1000 and a coupon rate of 6 per
cent has 10 years to maturity. What is the market price of this
bond if the market interest rate is 12 per cent?
( ) ( )
( )
( )
$660.99
3.1058
$1000
5.6502 $60
1.12
$1000

0.12
1.12 1/ 1
$60 V
10
10
=
+ =
+

=
5
Example 2Bond Value
Assume now that the bonds coupons are paid half-yearly.
( ) ( )
( )
( )
$655.90
3.2071
$1000
11.4699 $30
1.06
$1000

0.06
1.06 1/ 1
$30 V
20
20
=
+ =
+

=
6
Bond Values
If the market interest rate is the same
as the coupon rate, the bonds value is
the same as the face value.

If the market interest rate rises above
the coupon rate, the bonds value falls
below the face value. The bond is then
said to be a discount bond.

If the market interest rate falls below
the coupon rate, the bonds value rises
above the face value. The bond is then
said to be a premium bond.
7
Bond Yields
When interest rates rise, the present value of
the bonds remaining cash flows declines, and
the bond is worth less.

When interest rates fall, the bond is worth
more.

An inverse relationship exists between market
interest rates and bond price.
8
Interest Rate Risk
Interest rate risk is the risk that arises
for bond holders from changes in
interest rates.
How much interest rate risk a bond has
depends on how sensitive its price is to
interest rate changes. This depends on
two things:
All other things being equal, the longer the time to
maturity, the greater the interest rate risk.

All other things being equal, the lower the coupon
rate, the greater the interest rate risk.
9
Bond Yields

Yield to maturity (YTM) is the market interest rate
that equates a bonds present value of interest
payments and principal repayment with its price.

Given the yield to maturity or yield, we can
calculate the present value of the cash flows as an
estimate of the bonds current market value.

There is an inverse relationship between market
interest rates and bond price.
10
Bond Price Sensitivity to
Interest Rates (YTM)
4% 6% 8% 10% 12% 14% 16%
$1 800
$1 600
$1 400
$1 200
$1 000
$ 800
$ 600
Bond price
Yield to maturity, YTM
Coupon = $100
20 years to maturity
$1000 face value
Key Insight: Bond prices and
YTMs are inversely related.
11
Calculating Yield to Maturity
(YTM)
Yield to maturity (YTM) is the rate
implied by the current bond price.

Finding the YTM requires trial and error
if you do not have a financial calculator
and is similar to the process for finding
r with an annuity.

If you have a financial calculator, enter
N, PV, PMT and FV, remembering the
sign convention (PMT and FV need to
have the same sign, PV the opposite
sign).
12
ExampleCalculating YTM
Consider a bond with a 8 per cent
annual coupon rate, 10 years to
maturity and a par value of $1000. The
current price is $935.82.
Will the yield be more or less than 8 per
cent?

YTM = 9%