Professional Documents
Culture Documents
Bond Valuation and Their Valuation
Bond Valuation and Their Valuation
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Chapter overview
Coupon bonds
» Valuation
» Interest rate sensitivity
2
What is a Bond?
4
Types of Bonds: Issuers
Bonds Issuer
Government Bonds Government Agencies
Mortgage-Backed Securities Government agencies
Municipal Bonds State and local government
Corporate Bonds Corporations
Asset-Back Securities Corporations
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Government Bonds
Treasury Bills
» No coupons (zero coupon security)
» Face value paid at maturity
» Maturities up to one year
» Low risk and high liquidity
Treasury Notes
» Coupons paid semiannually/quarterly
» Face value paid at maturity
» Maturities from 2-10 years
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Government Bonds (Cont.)
Treasury Bonds
» Coupons paid semiannually
» Face value paid at maturity
» Maturities over 10 years
» The 30-year bond is called the long bond.
Treasury Strips (sell at discount and pay full amount at
maturity)
» Zero-coupon bond
» Created by “stripping” the coupons and principal from Treasury
bonds and notes.
No default risk. Considered to be risk free.
Exempt from state and local taxes.
Sold regularly through a network of primary dealers.
Traded regularly in the over-the-counter market. 7
Corporate Bonds
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Seniority of Corporate Bonds
Debentures
» Same priority as general creditors.
» Have priority over stockholders, but subordinate to secured debt.
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Bond Ratings
P= FV
(1+i)N
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Valuing Zero Coupon Bonds:
An Example
Value a 5 year, U.S. Treasury strip with face value of $1,000. The i=10% with
annual compounding? What about quarterly compounding?
If i = 12%, what will be the price of a zero-coupon bond if the maturity period
is 10 years? Whether there is any relationship between i and price of the zero-
coupon bond?
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Valuing Coupon Bonds
1 1
=CF − n + n F
i(1+i) (1+i)
i
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Valuing Coupon bonds - Example
Consider a bond pays 10% coupon rate with 5 years maturity period
and $1000 face value. The interest rate of the bond is i=12%. What
will be the price of the bond?
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Valuation of coupon bonds: if compounded
more than one per year (m=1)
e.g., If ABC bond pays 10% coupon per year and the coupon
payment is made quarterly with 12% discount rate, what will be the
price of the coupon bond?
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Yield to Maturity (YTM)
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Example:
If CR is 10% and FV is $1000 and the maturity period of the bond is
5 years with current market price $928. What will be the YTM of the
coupon bond? YTM = 11.86%
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