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Chapter 14. Bond Prices and Yields. Bond Characteristics. Face or par value Coupon rate Zero coupon bond Compounding and payments Accrued Interest Indenture. Different Issuers of Bonds. U.S. Treasury Notes and Bonds Corporations Municipalities - PowerPoint PPT Presentation
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Irwin/McGraw-Hill
14-14-11 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Bond PricesBond Pricesandand
YieldsYields
Chapter 14Chapter 14
Irwin/McGraw-Hill
14-14-22 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Face or par value Coupon rate
- Zero coupon bond Compounding and payments
- Accrued Interest Indenture
Bond CharacteristicsBond Characteristics
Irwin/McGraw-Hill
14-14-33 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Different Issuers of BondsDifferent Issuers of Bonds
U.S. Treasury
- Notes and Bonds Corporations Municipalities International Governments and Corporations Innovative Bonds
- Indexed Bonds
- Floaters and Reverse Floaters
Irwin/McGraw-Hill
14-14-44 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Secured or unsecured Call provision Convertible provision Put provision (putable bonds) Floating rate bonds Sinking funds
Provisions of BondsProvisions of Bonds
Irwin/McGraw-Hill
14-14-55 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Rating companies- Moody’s Investor Service
- Standard & Poor’s
- Duff and Phelps
- Fitch
Rating Categories- Investment grade
- Speculative grade
Default Risk and RatingsDefault Risk and Ratings
Irwin/McGraw-Hill
14-14-66 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Coverage ratios Leverage ratios Liquidity ratios Profitability ratios Cash flow to debt
Factors Used by Rating CompaniesFactors Used by Rating Companies
Irwin/McGraw-Hill
14-14-77 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Sinking funds Subordination of future debt Dividend restrictions Collateral
Protection Against DefaultProtection Against Default
Irwin/McGraw-Hill
14-14-88 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
)1()1(1 rParValue
rCP T
T
T
tt
tB
PB = Price of the bond
Ct = interest or coupon payments
T = number of periods to maturity
y = semi-annual discount rate or the semi-annual yield to maturity
Bond PricingBond Pricing
Irwin/McGraw-Hill
14-14-99 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
t=1+
20
= P B 40 1(1+.03) t 1000 1
(1+.03) 20
Ct = 40 (SA)P = 1000T = 20 periodsr = 3% (SA)
PB = $1,148.77
Solving for Price: 10-yr, 8% Coupon Solving for Price: 10-yr, 8% Coupon Bond, Face = $1,000Bond, Face = $1,000
Irwin/McGraw-Hill
14-14-1010 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Prices and Yields (required rates of return) have an inverse relationship
When yields get very high the value of the bond will be very low
When yields approach zero, the value of the bond approaches the sum of the cash flows
Bond Prices and YieldsBond Prices and Yields
Irwin/McGraw-Hill
14-14-1111 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Price
Yield
Prices and Coupon RatesPrices and Coupon Rates
Irwin/McGraw-Hill
14-14-1212 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Yield to MaturityYield to Maturity
Interest rate that makes the present value of the bond’s payments equal to its price
Solve the bond formula for r
)1()1(1 rParValue
rCP T
T
T
tt
tB
Irwin/McGraw-Hill
14-14-1313 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Yield to Maturity ExampleYield to Maturity Example
)1(1000
)1(35950
20
1 rrT
tt
10 yr Maturity Coupon Rate = 7%
Price = $950
Solve for r = semiannual rate r = 3.8635%
Irwin/McGraw-Hill
14-14-1414 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Yield MeasuresYield Measures
Bond Equivalent Yield
7.72% = 3.86% x 2
Effective Annual Yield
(1.0386)2 - 1 = 7.88%
Current Yield
Annual Interest / Market Price
$70 / $950 = 7.37 %
Irwin/McGraw-Hill
14-14-1515 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Realized Yield versus YTMRealized Yield versus YTM
Reinvestment Assumptions Holding Period Return
- Changes in rates affects returns
- Reinvestment of coupon payments
- Change in price of the bond
Irwin/McGraw-Hill
14-14-1616 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Holding-Period Return: Holding-Period Return: Single PeriodSingle Period
HPR = [ I + ( P0 - P1 )] / P0
where
I = interest payment
P1 = price in one period
P0 = purchase price
Irwin/McGraw-Hill
14-14-1717 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Holding-Period ExampleHolding-Period Example
CR = 8% YTM = 8% N=10 years
Semiannual Compounding P0 = $1000
In six months the rate falls to 7%
P1 = $1068.55
HPR = [40 + ( 1068.55 - 1000)] / 1000
HPR = 10.85% (semiannual)
Irwin/McGraw-Hill
14-14-1818 The McGraw-Hill Companies, Inc., 1999
INVESTMENTSFourth Edition
Bodie Kane Marcus
Holding-Period Return: MultiperiodHolding-Period Return: Multiperiod
Requires actual calculation of reinvestment income
Solve for the Internal Rate of Return using the following:- Future Value: sales price + future value of
coupons
- Investment: purchase price
