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Valuing Bonds
Chapter Outline
8.1 Bond Cash Flows, Prices, and Yields
8.2 Dynamic Behavior of Bond Prices
8.3 The Yield Curve and Bond Arbitrage
8.4 Corporate Bonds
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Learning Objectives
1. Identify the cash flows for both coupon bonds and zerocoupon bonds, and calculate the value for each type
of bond.
2. Calculate the yield to maturity for both coupon and zerocoupon bonds, and interpret its meaning for each.
3. Given coupon rate and yield to maturity, determine
whether a coupon bond will sell at a premium or a
discount; describe the time path the bonds price will
follow as it approaches maturity, assuming prevailing
interest rates remain the same over the life of the bond.
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Maturity Date
Final repayment date
Term
The time remaining until the repayment date
Coupon
Promised interest payments
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Coupon Rate
Determines the amount of each coupon payment,
expressed as an APR
Coupon Payment
CPN
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Zero-Coupon Bonds
Zero-Coupon Bond
Does not make coupon payments
Always sells at a discount (a price lower than face
value), so they are also called pure discount bonds
Treasury Bills are U.S. government zero-coupon
bonds with a maturity of up to one year.
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FV
P
(1 YTM n ) n
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100,000
96,618.36
1.035
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YTM n
FV
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Example 8.1
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rn YTM n
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Coupon Bonds
Coupon Bonds
Pay face value at maturity
Pay regular coupon interest payments
Treasury Notes
U.S. Treasury coupon security with original maturities of
110 years
Treasury Bonds
U.S. Treasury coupon security with original maturities
over 10 years
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Example 8.2
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1
1
FV
P CPN
1
N
y
(1 y )
(1 y ) N
Copyright 2009 Pearson
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Example 8.3
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Example 8.4
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Par
A bond is selling at par if the price is equal to the
face value.
Premium
A bond is selling at a premium if the price is greater
than the face value.
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Example 8.5
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Example 8.6
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Figure 8.1
The Effect of Time on Bond Prices
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Example 8.7
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Figure 8.2
Yield to
Maturity and
Bond Price
Fluctuations
Over Time
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L
2
1 YTM 1
(1 YTM 2 )
CPN FV
(1 YTM n ) n
100
100
100 1000
P
$1153
2
3
1.035
1.04
1.045
Copyright 2009 Pearson
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2
(1 y )
(1 y )
(1 y )3
100
100
100 1000
P
$1153
2
3
1.0444
1.0444
1.0444
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Example 8.8
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On-the-Run Bonds
Most recently issued bonds
The yield curve is often a plot of the yields on
these bonds.
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Credit Risk
Risk of default
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1000
1000
P
$961.54
1 YTM 1
1.04
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900
900
$865.38
1 YTM 1
1.04
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Bond Ratings
Investment Grade Bonds
Speculative Bonds
Also known as Junk Bonds or High-Yield Bonds
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Questions?
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