Chapter 3 - Valuing A Bond

Ton Duc Thang University
Finance and Banking Faculty

Corporate Finance Department
FINANCIAL MANAGEMENT
CHAPTER 3
VALUING A BOND
Course Code: B02037

Prepared by: Corporate Finance Department
9/17/2023 B02037 – Chapter 3: Valuing a Bond 1

Before-Class Assignment
(Day 3)

(Day 3)
Q1:
After retirement, you expect to live for 25 years. You would
like to have $75,000 income each year. How much should
you have saved in the retirement to receive this income, if
the interest is 9% per year (assume that the payments start
one year after the retirement)?

(Day 3) (con’t)
Q2:
the interest is 9% per year (assume that the payments start
on the day of retirement)?

(Day 3) (con’t)
Q3:
Mr. Trump is expected to retire in 25 years and he wishes
accumulate $750,000 in his retirement fund by that time. If
the interest rate is 10% per year, how much should Mr.
Trump into the retirement fund each year in order to
achieve this goal? Assume that the payments are made at
the end of each year.

(Day 3) (con’t)
Q4:
the interest is 10% per year (assume that the payments
start on the day of retirement)?

After-Class Assignment
(Day 3)
Q1:
You have to pay $12,500 a year in school fees at the end of
each of the next six years. If the interest rate is 8%, how
much do you need to set aside today to cover these bills?
You have invested $70,476 at 8%. After paying the above
school fees, how much would remain at the end of the six
years?

(Day 3) (con’t)
Q2:
Mr. Sugar has taken a $250,000 mortgage on his house at
an interest rate of 6% per year. If the mortgage calls for
twenty equal annual payments, what is the amount of each
payment?

(Day 3) (con’t)
Q3:
Ms. Trang has just taken out a $150,000 mortgage at an
interest rate of 6% per year. If the mortgage calls for equal
monthly payments for twenty years, what is the amount of
each payment? (Assume monthly compounding or
discounting.)

(Day 3) (con’t)
Q4:
You borrow $150,000 to buy a house. The mortgage rate is
8.5 percent and the loan period is 30 years. Payments are
made monthly. If you pay for the house according to the
loan agreement, how much total interest will you pay?

(Day 3) (con’t)
Q5:
The discount rate is 10 percent for five years, compounded
quarterly. What is the difference in the present value of
these two sets of the following payments?
Case 1: you receive $200 on the first day of each quarter.
Case 2: you receive $200 on the last day of each quarter.

(Day 3) (con’t)
Q6:
You agree to lease a car for 5 years at $250 per month. You
are not required to pay any money up front or at the end of
your agreement. If your opportunity cost of capital is 0.3%
per month, what is the cost of the lease?

(Day 3) (con’t)
Q7:
A factory costs $750,000. You reckon that it will produce an
inflow after operating costs of $150,000 a year for 8 years.
If the opportunity cost of capital is 14%, what is the net
present value of the factory? What will the factory be worth
at the end of five years?

(Day 3) (con’t)
Q8:
I order to save money for travelling to Europe, I have to
deposit 30 million VNĐ at the end of each year, during 3
years. Help me to calculate the total money I get in my
account at the end of year 3, if the interest rate is 8%,
compounding semi-annually?

(Day 3) (con’t)
Q9:
Khanh is planning for retirement. He expects to retire 28
years from now, at which time he wishes to have
accumulated $2,500,000 in his retirement fund (money at
that time). If the interest rate is 3% per year, how much
should Khanh put into his retirement fund at the end of
each year in order to achieve his goal?

(Day 4)
1. A government bond has a coupon rate of 5%, face value

of euros 100 and maturing in five years. The interest
payments are made annually. Calculate the price of the
bond (in euros) if the yield to maturity is 3.5%.
2. A three-year bond has 8.0% coupon rate and face value
of $1,000. If the yield to maturity on the bond is 10%,
calculate the price of the bond assuming that the bond
makes semi-annual coupon interest payments.
3. A 20-year zero coupon bond has a $1,000 face value, a
required rate of return of 5 percent, and semiannually
compounding. What is this bond worth today?

(Day 4)
1. Given a 5-year annual coupon bond with a face value of
$1,000, coupon rate of 8.5% and a yield to maturity of
7%.
a. Calculate the Macaulay duration of this bond
b. If yield to maturity decreases from 7% to 5.2%,
calculate the price of bond after yield to maturity
changes
$1000, coupon rate of 9% and a yield to maturity of 12%.
changes
TOPICS COVERED IN
CHAPTER 3
• What is a Bond?
• Face Value, Coupon Payment, YTM
• Present Value of a Bond
• Duration
• Volatility
• Calculate the Price of a Bond after YTM
changes

WHAT IS A BOND?
Balance Sheet
Liabilities
Assets
Equity

WHAT IS A BOND?
Balance Sheet
Long term debt

=> BOND
Assets
Equity =>
STOCK

FACE VALUE, COUPON
PAYMENT, YTM
Face Value
Long term debt

Coupon Payment
=> BOND
Equity =>
STOCK
Yield-to-maturity

FACE VALUE, COUPON
PAYMENT, YTM
Face Value
US: 1,000$; Europe: 100 euro; Viet
Nam: 10 million dong
Long term debt

Coupon Payment
=> BOND
Equity =>
STOCK
Yield-to-maturity

FACE VALUE, COUPON
PAYMENT, YTM
Face Value
Long term debt Coupon Payment

= Coupon Rate x Face Value
=> BOND 2 types: Annual and Semi-Annual
Equity =>
STOCK
Yield-to-maturity

FACE VALUE, COUPON
PAYMENT, YTM
Face Value
Long term debt Coupon Payment

= Coupon Rate x Face Value
=> BOND 2 types: Annual and Semi-Annual
Equity =>
STOCK
Yield-to-maturity
= Discount rate (%)

PRESENT VALUE OF A BOND
Long term debt

=> BOND
Coupon Payment Face Value
= Coupon Rate x Face Value US: 1,000$; Europe: 100 euro; Viet
2 types: Annual and Semi-Annual Nam: 10 million dong
C C C C C C C C C C + FaceValue
0 1 2 3 4 5 6 7 8 9 10
Yield-to-maturity
= Discount rate (%)


Yield-to-maturity
= Discount rate (%)
0 1 2 3 4 5 6 7 8 9 10
−𝑛
1− 1+𝑟 𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒
𝑃𝑉 = 𝐶 × +
𝑟 1+𝑟 𝑛


Yield-to-maturity
= Discount rate (%)
0 1 2 3 4 5 6 7 8 9 10
−𝑛∗2
1 − 1 + 𝑟/2 𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒
𝑃𝑉 = 𝐶 × +
𝑟/2 1 + 𝑟/2 𝑛∗2

Example
1. A government bond has a coupon rate of 5%, face value

of euros 100 and maturing in five years. The interest
payments are made annually. Calculate the price of the
bond (in euros) if the yield to maturity is 3.5%.
2. A three-year bond has 8.0% coupon rate and face value
of $1,000. If the yield to maturity on the bond is 10%,
calculate the price of the bond assuming that the bond
makes semi-annual coupon interest payments.
3. A 20-year zero coupon bond has a $1,000 face value, a
required rate of return of 5 percent, and semiannually
compounding. What is this bond worth today?

DURATION
1− 1+𝑟 −𝑛 𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒

𝑃𝑉 = 𝐶 × +
𝑟 1+𝑟 𝑛
0 1 2 3 4 5 6 7 8 9 10

DURATION
Year Ci PV(Ci)
1 C C / (1 + r)^1
2 C C / (1 + r)^2
3 C C / (1 + r)^3
n C + Face Value (C + Face Value) / (1 + r)^n
0 1 2 3 4 5 6 7 8 9 10

DURATION
𝟏 × 𝑷𝑽(𝑪𝟏 ) 𝟐 × 𝑷𝑽(𝑪𝟐 ) 𝟑 × 𝑷𝑽(𝑪𝟑 ) 𝒏 × 𝑷𝑽(𝑪𝒏 )

Duration = + + +. . . +
𝑷𝑽 𝑷𝑽 𝑷𝑽 𝑷𝑽
• Duration can be thought of as the weighted average time of a bond's cash

flow. The weights are determined by the present value factors. Duration is
expressed in units of time. Duration is an important concept for two reasons.
First, the volatility of a bond is directly related to its duration. Second, one
way to hedge interest rate risk is through a strategy of duration matching.
• The duration of a zero-coupon bond is the same as its maturity.

DURATION
Example
1. A bond with a face value of $1,000 has coupon rate of

7%, yield to maturity of 10%, and twenty years to
maturity. What is the bond's duration?
2. A bond with a face value of $1,000, coupon rate of 0%,
yield to maturity of 9%, and ten years to maturity. What is
the bond's duration?
3. Consider a bond with a face value of $1,000, a coupon
rate of 6%, a yield to maturity of 4%, and five years to
maturity. What is bond's duration?

VOLATILITY
duration
Modified Duration = volatility (%) =
1 + yield
• Volatility is calculated as Duration/ (1 + yield). Bonds with longer duration

also have greater volatility. Bond's volatility is directly related to duration.
Volatility is also the slope of the curve relating the bond price to the interest
rate.
• Volatility of a bond is given by: Duration/ (1 + yield)
• Slope of the curve relating the bond price to the interest rate
• The longer a bond's duration, the greater its volatility.

VOLATILITY
Example
1. A bond with duration of 10 years has yield to maturity of

10%. What is this bond's volatility?
2. If a bond's volatility is 5 and the interest rate changes by
0.5% (points) then the price of the bond:
• YTM changes by 1% will influence on the Price of the
bond changes direction in reverse by 5%.
• YTM changes by 0.5% will influence on the Price of the
bond changes direction in reverse by 2.5%.

VOLATILITY
Example
3. A 12-year, 5 percent coupon bond with a face value of

$1,000 pays interest semiannually. What is the
percentage change in the price of this bond if the market
yield rises to 6 percent from its current level of 4.5
percent?
4. A 15-year, 4 percent coupon bond with a face value of
$1,000 pays interest semiannually. Assume the bond
currently sells at par (Price = Face value). What will the
percentage change in the price of this bond be if market
rates increase by 10 percent?

CALCULATE THE PRICE OF A
BOND AFTER YTM CHANGES
−𝑛
1− 1+𝑟 𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒
𝑃𝑉 = 𝐶 × +
𝑟 1+𝑟 𝑛
𝟏 × 𝑷𝑽(𝑪𝟏 ) 𝟐 × 𝑷𝑽(𝑪𝟐 ) 𝟑 × 𝑷𝑽(𝑪𝟑 ) 𝒏 × 𝑷𝑽(𝑪𝒏 )

Duration = + + +. . . +
𝑷𝑽 𝑷𝑽 𝑷𝑽 𝑷𝑽
duration
Modified Duration = Volatility (%) =
1 + yield
𝑷𝟏 − 𝑷𝟎
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝒂 𝑩𝒐𝒏𝒅 =
𝑷𝟎
= 𝑽𝒐𝒍𝒂𝒕𝒊𝒍𝒊𝒕𝒚 × 𝒀𝑻𝑴 𝒂𝒇𝒕𝒆𝒓 − 𝒀𝑻𝑴 𝒃𝒆𝒇𝒐𝒓𝒆

CALCULATE THE PRICE OF A
BOND AFTER YTM CHANGES
Example

$1,000, coupon rate of 8.5% and a yield to maturity of
7%.
changes.
$1000, coupon rate of 9% and a yield to maturity of 12%.
changes.
Structure of interest rate
Self-study
• The term structure of interest rate is the relationship between yield to

maturity and maturity.
• If the term structure of interest rate is flat the nine-year interest rate is equal
to the ten-year interest rate.
• The term structure of interest rates is the plot of interest rates on the y-axis
and the maturity on the x-axis. It is also called the yield curve. It shows how
interest rates and maturity are related. Economists have developed several
theories to explain the shape of the yield curve.
• The term structure of interest rates can be described as the relationship
between spot interest rates and maturity of a bond.

Self-study
➢ 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.

Self-study
YTM (r)
1981
1987 & Normal
1976
Year
1 5 10 20 30
Spot Rate - The actual interest rate today (t=0)
Forward Rate - The interest rate, fixed today, on a loan
made in the future at a fixed time.
Future Rate - The spot rate that is expected in the future
Yield To Maturity (YTM) - The IRR on an interest bearing
instrument

Self-study
What Determines the Shape of the Term Structure?
Expectations Theory
Term Structure & Capital Budgeting

• CF should be discounted using Term Structure info
• Since the spot rate incorporates all forward rates, then
you should use the spot rate that equals the term of
your project.
• If you believe in other theories take advantage of the
arbitrage.

Relationship between bond prices
and interest rates
Self-study
• Interest rates and bond prices are inversely related. High interest rates cause
bond prices to fall and vice-versa. For a given change in interest rates, prices of
long-term bonds fluctuate more than for short-term bonds. Similarly, for a given
change in interest rates low coupon bond prices fluctuate more than for high
coupon bonds.

Spot rates & Forward rates
Self-study
• Yield to maturity is the weighted average of spot interest rates and estimated
forward rates.
• A forward rate prevailing from period three through to period four can be
extracted from spot interest rate with 3 and 4 years to maturity.
• Interest represented by "r2" is: Spot rate on a two-year investment (APR).
• One person can invest today at the 2-year forward rate of interest by buying a 2-
year bond and selling a 1-year bond with the same coupon.
• The relationship between spot and forward rates: A forward rate is the internal
rate of return derived from the future value of bonds given spot rates from two
different maturity bonds.

Spot rates (%)
9/18/2023
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
2009 Aug 15 2009
2011 Aug 15
2013 Aug 15
2015 Aug 15
2017 Aug 15
2019 Aug 15
2021 Aug 15
2023 Aug 15
Maturity
2025 Aug 15
2027 Aug 15
2029 Aug 15
Self-study
2031 Aug 15
B02037 – Chapter 3: Valuing a Bond

2033 Aug 15
2035 Aug 15
2037 Aug 15
U.S. Treasury Strip Spot Rates as of February
Spot rates & Forward rates
44
Expectation theory
Self-study
• The expectations theory implies that the only reason for a declining term
structure is that investors expect spot interest rates to fall.
• The expectations theory postulates that the current forward rates are the
expected value of the corresponding future spot rates.
• The expectations hypothesis states that the forward interest rate is the
expected future spot rate.

Real rates and nominal rates
Self-study
• Classical Theory of Interest Rates (Economics), developed by Irving

Fisher.
• Nominal Interest Rate = The rate you actually pay when you borrow
money.
• Real Interest Rate = The theoretical rate you pay when you borrow
money, as determined by supply and demand
r
Supply
Real r
Demand
$ Qty
Self-study
• The relationship between nominal interest rate and real interest rate is given by:
• It can also be written as:
• Real interest rate is the inflation adjusted nominal interest rate.

Self-study

Bond Ratings
Self-study
• Key to bond ratings. The highest-quality bonds are rated triple A. Bonds
rated triple B or above are investment grade. Lower-rated bonds are called
high-yield, or junk, bonds.
➢ Prices and yields of a sample of corporate bonds, December 2008.

Ton Duc Thang University
Finance and Banking Faculty
Corporate Finance Department
Thank you for your attention

I wish you all the best!
Dr. Ngô Nguyễn Quỳnh Như

Chapter 3 - Valuing A Bond

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 3 - Valuing A Bond

Uploaded by

Copyright:

Available Formats

Ton Duc Thang University

Finance and Banking Faculty

Course Code: B02037

9/17/2023 B02037 – Chapter 3: Valuing a Bond 1

9/17/2023 B02037 – Chapter 3: Valuing a Bond 2

9/17/2023 B02037 – Chapter 3: Valuing a Bond 3

9/17/2023 B02037 – Chapter 3: Valuing a Bond 4

9/17/2023 B02037 – Chapter 3: Valuing a Bond 5

9/17/2023 B02037 – Chapter 3: Valuing a Bond 6

9/17/2023 B02037 – Chapter 3: Valuing a Bond 7

9/17/2023 B02037 – Chapter 3: Valuing a Bond 8

9/17/2023 B02037 – Chapter 3: Valuing a Bond 9

9/17/2023 B02037 – Chapter 3: Valuing a Bond 10

9/17/2023 B02037 – Chapter 3: Valuing a Bond 11

9/17/2023 B02037 – Chapter 3: Valuing a Bond 12

9/17/2023 B02037 – Chapter 3: Valuing a Bond 13

9/17/2023 B02037 – Chapter 3: Valuing a Bond 14

9/17/2023 B02037 – Chapter 3: Valuing a Bond 15

1. A government bond has a coupon rate of 5%, face value

9/18/2023 B02037 – Chapter 3: Valuing a Bond 16

9/17/2023 B02037 – Chapter 3: Valuing a Bond 18

9/17/2023 B02037 – Chapter 3: Valuing a Bond 19

Long term debt

9/17/2023 B02037 – Chapter 3: Valuing a Bond 20

Long term debt

9/17/2023 B02037 – Chapter 3: Valuing a Bond 21

Long term debt

9/17/2023 B02037 – Chapter 3: Valuing a Bond 22

Long term debt Coupon Payment

9/17/2023 B02037 – Chapter 3: Valuing a Bond 23

Long term debt Coupon Payment

9/17/2023 B02037 – Chapter 3: Valuing a Bond 24

Long term debt

9/17/2023 B02037 – Chapter 3: Valuing a Bond 25

Coupon Payment Face Value

9/17/2023 B02037 – Chapter 3: Valuing a Bond 26

Coupon Payment Face Value

9/17/2023 B02037 – Chapter 3: Valuing a Bond 27

1. A government bond has a coupon rate of 5%, face value

9/18/2023 B02037 – Chapter 3: Valuing a Bond 28

1− 1+𝑟 −𝑛 𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒

9/17/2023 B02037 – Chapter 3: Valuing a Bond 29

9/17/2023 B02037 – Chapter 3: Valuing a Bond 30

𝟏 × 𝑷𝑽(𝑪𝟏 ) 𝟐 × 𝑷𝑽(𝑪𝟐 ) 𝟑 × 𝑷𝑽(𝑪𝟑 ) 𝒏 × 𝑷𝑽(𝑪𝒏 )

• Duration can be thought of as the weighted average time of a bond's cash

9/18/2023 B02037 – Chapter 3: Valuing a Bond 31

1. A bond with a face value of $1,000 has coupon rate of

9/18/2023 B02037 – Chapter 3: Valuing a Bond 32

• Volatility is calculated as Duration/ (1 + yield). Bonds with longer duration

9/18/2023 B02037 – Chapter 3: Valuing a Bond 33

1. A bond with duration of 10 years has yield to maturity of

9/18/2023 B02037 – Chapter 3: Valuing a Bond 34

3. A 12-year, 5 percent coupon bond with a face value of

9/18/2023 B02037 – Chapter 3: Valuing a Bond 35

𝟏 × 𝑷𝑽(𝑪𝟏 ) 𝟐 × 𝑷𝑽(𝑪𝟐 ) 𝟑 × 𝑷𝑽(𝑪𝟑 ) 𝒏 × 𝑷𝑽(𝑪𝒏 )

9/18/2023 B02037 – Chapter 3: Valuing a Bond 36

1. Given a 5-year annual coupon bond with a face value of

• The term structure of interest rate is the relationship between yield to

9/18/2023 B02037 – Chapter 3: Valuing a Bond 38

➢ Short- and long-term interest rates do not always move in

9/18/2023 B02037 – Chapter 3: Valuing a Bond 39

9/18/2023 B02037 – Chapter 3: Valuing a Bond 40

What Determines the Shape of the Term Structure?