Bond Valuation

Professor Ronald Miolla

Agenda

• What is a bond?• How are bonds valued?• Interest rate changes and bond values.

What is a Bond?

• Issuer: IBM or the US Treasury• Face or Principal value: $25000• Recorded as Liabilities on the balance sheet• A source of financing. A=L+OE• Term: 30 years• Coupon: $ amount , 6 months, $1,250• Callable: can be paid back early, ex 10 years• Yield is a calculation: 2,500/25,000=10%.

Bond Valuation

• A bond is just cash flows.• Previous example: to the buyer it is a $25,000

cash outflow in the present. It returns a $1,250 annuity for 60 periods (semiannually), a cash inflow. It also is a $25,000 single payment cash inflow in year 30.

• The bonds price or value is the value of the two inflows at the current discount rate (yield to maturity, or interest rate).

Interest Rate Changes

• If rates go down, say to 3%, then the discount rate to value the bond is 3% rather than 10% => higher present value of the inflows (bond price).

• If rates go up, say 15% then the bond’s price goes down.

Summary

• A bond is a financial security.• Bonds are used to finance a company or

government.• Bonds are contracted cash flows.• Interest rate changes impact bond values.