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Presentation 2. Understanding The Interest Rates. The Yield To Maturity
Presentation 2. Understanding The Interest Rates. The Yield To Maturity
Frederick University
2014
Yield to Maturity
The yield to maturity is the
interest rate that makes the
discounted value of the future
payments from a debt instrument
equal to its current value (market
price) today.
It is the yield bondholders receive if
they hold a bond to its maturity.
Bonds: 4 types
Discount bonds - zero coupon bonds
(government bonds)
fixed payment loans
coupon bonds
(government bonds, corporate bonds)
consols
example
90 day bond,
P = 9850, F = 10,000
YTM solves
9850
10,000
(1 i )
90
365
9850
1 i
10,000
(1 i )
90
365
90
365
10000
9850
10000
1 i
9850
10000
i
9850
365
365
90
90
F-P
idb =
F
360
d
example
90 day bond,
P = 9850, F = 10,000
discount yield =
150 360
X
6%
10,000 90
why?
F in denominator
360 day year
i is annual rate
but payments are monthly, &
compound monthly
i = i/12
300
300
300
5000
...
2
60
1 i / 12 1 i / 12
1 i / 12
Coupon bond
a 2-year coupon bond
a face value F = 10,000,
a coupon rate i = 6%,
a price P =9750.
bond price = PV(future bond
payments)
The coupon payments are
[face value x coupon rate]/2 =
or:
i = 7.37%
3 important points
Consols (or
perpetuities)
Consols (or perpetuities) promise
interest payments forever, but never
repay principal.
Bond Yields
P = PV of cash flows
Current yield
ic =
example
600
ic =
9750
= 6.15%
holding period
interest payments
resale price
example
300 at 6 mos.
300 at 1 yr.
9900 at 1 yr.
2
i
i
1
1
2
2
i/2 = 3.83%
i = 7.66%
why i/2?
interest compounds annually not
semiannually