1 bond valuation issuer (seller) investors (buyers) $ $$ bond contract

18
1 Bond Valuation Issuer (Seller ) Investor s (Buyers) $$$ Bond Contract

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Page 1: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

1

Bond Valuation

Issuer (Seller)Investors

(Buyers) $$$

Bond Contract

Page 2: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

2

Bond Contract

How much should you pay ? Bond Value = ?

Par

C C C C C1

2

41 2 3 n

Buy the bond today

Page 3: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Value of Bond today

= C (PVIFA i, n) + Par (PVIF i,

n)Bond Value C = Coupon Payment = coupon rate x par

Par value or Face Value = $1,000

Par

C C C C C1

2

41 2 3 n

Page 4: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

4

An example

You buy bond with $1,000 par value, Coupon rate 9% paid once per year, 5 years until maturity. Assume interest rate is 3%. What is the value of this bond?

1,000

90 90 90 90 90

Vb = + PAR x PVIF i, nC x PVIFA i, n

+ 1,000 x PVIF 3%,590 x PVIFA 3%,51,274.77

Page 5: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Find value of bond with $1,000 par value, Coupon rate

15% paid once per year, 4 years until maturity

Vb = C (PVIFA i,n) + Par (PVIF i,n)

$ 1,158.49

$ 1,000

$ 870.61

Bond Price

= 10%

= 15%

= 20%

If interest

Bond sold at Premium

Bond is sold at Par

Bond sold at Discount

Price-Yield relationship

Page 6: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Semiannual coupon payment

Coupon per period = coupon per year ÷ 2

Find value of bond with 10% coupon rate paid semiannually, 10

years maturity. Interest rate is 6%

Bond Value = C (PVIFA i/2,nx2) + Par (PVIF i/2,nx2)

Coupon per period = 10% x 1,000 ÷ 2

= 50

Vb = 50 (14.8775) + 1,000 (0.5537)

Vb = 50 (PVIFA 3% , 20 ) + 1,000 (PVIF 3% , 20 )

Vb = 1,297.57

Page 7: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Finding the interest rate (YTM)

= coupon per year + [(par – price) ÷ n]

(par + price) ÷ 2

***coupon per year = coupon rate x par

***par = $1,000

***price = market price

***n = number of years

Page 8: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Finding the interest rate (YTM)

= coupon per year + [(par – price)

÷ n]

(par + price) ÷ 2

***coupon per year = 10% x 1000 = $ 100

***par = $1,000

***price = $ 850

***n = 5 years

Page 9: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Finding the interest rate (YTM)

= $ 100 + [(1,000 – 850) ÷ 5]

(1,000 + 850) ÷ 2

***coupon per year = 10% x 1000 = $ 100

***par = $1,000

***price = $ 850

***n = 5 years

Page 10: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Finding the interest rate (YTM)

= $ 100 + [(1,000 – 850) ÷ 5]

(1,000 + 850) ÷ 2

= $ 100 + 30

925

= 0.1405 = 14.05 %

Page 11: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Finding the interest rate (YTM)

= $ 160 + [(1,000 – 1,100) ÷ 10]

(1,000 + 1,100) ÷ 2

***coupon per year = 16% x 1000 = $ 160

***par = $1,000

***price = $ 1,100

***n = 10 years

Page 12: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Finding the interest rate (YTM)

= $ 160 + [(1,000 – 1,100) ÷ 10]

(1,000 + 1,100) ÷ 2

= $ 160 - 10

1,050

= 0.1429 = 14.29 %

Page 13: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Exercise

1. A corporate bond with a coupon rate of 7% matures in 4 years. Its price is currently $1,150. - Calculate the current yield on this bond- Calculate the yield to maturity on this bond

Page 14: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Current Yield Formula

The current yield refers simply to the annual

payment (coupon) divided by the price.

Yc = R/Pwhere

Yc is the current yield, R is the annual coupon payment in

dollars, P is the market price.

Page 15: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Current Yield Example

Market price of 5-years treasury bond is $1,020. the bond is

paying a coupon of $50 per year. Find the current yield.

Yc = 501020

Yc = 0.049 or 4.9%

Page 16: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Comparing bond value & market price

If the market price of Bond < Bond Value

Then the Bond is “Cheap” Bond is Undervalued (Underpriced) Investors will buy the Bond

Demand > Supply Price will increase

Page 17: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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Comparing bond value & market price

If the market price of Bond > Bond Value

Then the Bond is “Expensive” Bond is Overvalued (Overpriced) Investors will sell the Bond

Demand < Supply Price will decrease

Page 18: 1 Bond Valuation Issuer (Seller) Investors (Buyers) $ $$ Bond Contract

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A bond will have a higher price if:

Interest rate (yield) is …………….(higher/lower)

Coupon rate, payment is …………….(higher/lower)

Maturity is ……….(longer/shorter)