Chap 04_Bonds_rev.pptVIP

Valuing Bonds Chapter 4 The Fundamental Valuation Model Bond Vocabulary Bond Vocabulary Bond Valuation: The Basic Equation Yield to Maturity (YTM) Bond Premiums and Discounts What happens to bond values if the required return is not equal to the coupon rate? On Discount Rates Generally, the greater the uncertainty about an asset’s future benefits, the higher the discount rate investors will apply when discounting those benefits to the present. Semiannual Compounding Economic Forces Affecting Bond Prices Interest Rate Risk Treasury Bond Yields and Inflation Rates Primary versus Secondary Markets Types of Bonds: By Issuer Types of Bonds: By Features Types of Bonds: By Features Table 4.1 Zero-Coupon Bond Prices and Taxable Income Types of Bonds: By Features Bond Ratings Figure 4.2 Bond Ratings Term Structure of Interest Rates Relationship between yield and maturity is called the Term Structure of Interest Rates Graphical depiction called a Yield Curve Usually, yields on long-term securities are higher than on short-term securities. Generally look at risk-free Treasury debt securities Yield curves normally upwards-sloping Long yields short yields Can be flat or even inverted during times of financial stress The Expectations Hypothesis Advanced Bond Valuation Valuing Bonds Bond price = present value of coupons + present value of principal Bond prices are inversely related to interest rates. Bonds can have features like convertibility and callability. -Yield to Maturity (YTM) is the rate of return investors earn if they buy the bond at P0 and hold it until maturity. The YTM on a bond selling at par (P0 = Par) will always equal the coupon interest rate. When P0 ? Par, the YTM will differ from the coupon rate. YTM is the discount rate that equates the PV of a bond’s cash flows with its price. If P0, CFs, n known, can find YTM Use T-Bond with n=2 years, 2n=4, C/2=$20, P0=$992.43 The relationship between nominal (observed) and real (inflation-adjusted) interest rates