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Bond Yields and Prices
Bond Yields and Prices
1 1 1
1
(1 ) (1 )
T T
Coupon ParValue
r r r
| |
+
|
+ +
\ .
Bond Prices and Interest Rates
There is an inverse relationship between bond prices and
yields.
Bond Price
The relationship between bond prices and yields is convex.
Interest Rate
Bond Yields
Current Yield is the ratio of the coupon interest to current
market price.
Yield to Maturity (YTM) is defined as the compound rate of
return an investor will receive from a bond purchased at the
current market price and held to maturity.
YTM makes the present value of a bonds payments equal to
its price.
Yield to Maturity
Where P = the current price of the bond
T = the number of semi-annual periods to maturity
ytm = the semi-annual yield to maturity to be solved
for
c = the semiannual coupon in amount
FV = the face value (or maturity value or par value)
The annual YTM (bond equivalent yield) is equal to 2 x ytm
1
(1 ) (1 )
T
t
t T
t
c FV
P
ytm ytm
=
= +
+ +
Example-YTM
Coupon Rate : 10% Time to Maturity: 3 years
Coupon Payment : Half-yearly FV: Rs.1,000
MV: Rs.1052.42
Since the bond is selling at a premium , ytm is lower than the
coupon rate.
With a 4% discount rate the PV is Rs.1052.10. The semi-annual
yield is 4% and annual yield is 8%
6
6
1
50 1000
1052.42
(1 ) (1 )
t
t
ytm ytm
=
= +
+ +
YTM-An Approximation
YTM can be approximated using the following equation:
Where C is the coupon payment per period,
M is the maturity value of the bond ,
P is the present price of the bond and
n the number of coupon payments,
( ) /
0.4 0.6
C M P n
YTM
M P
+
+
YTM of Zero-Coupon Bond
The yield to maturity of a zero-coupon bond is given by:
For a premium bond, Coupon Rate > Current Yield > YTM
1
[ / ] 1
n
ytm FV P =
Example YTM of Zero
A zero-coupon bond has 12 years to maturity and is selling for
Rs.300.
The ytm is given by:
=
YTM = 10.3%
1
1
T
FV
ytm
P
| |
=
|
\ .
1
24
1000
1 0.0515
300
| |
=
|
\ .
Yield to Call
The yield to call is the expected yield to the end of the
deferred call period when a bond can first be called.
where
fc = the number of semiannual periods until the first call date
yc = the yield to first call on a semiannual basis
CP = the call price to be paid by the issuer if the bond is called
1
(1 ) (1 )
fc
t
t fc
t
c CP
P
yc yc
=
= +
+ +