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Bruce Tuckman, Fixed Income Securities, 2nd Edition (Hoboken, NJ: John Wiley Sons, 2002) Chapter 1 – Bond Prices, Discount Factors, and Arbitrage AIM 1: Describe and contrast individual and market expressions of the time value of money. DETERMINING THE CASH FLOWS Coupons are often stated in annual terms and must be adjusted for periodicity. Once the cash flows are determined, the present value (PV) of the cash flows can be computed. FOUNDAMENTALS OF BOND VALUATION The value (or price) of any financial assets – such as a bond – can be determined by summing the asset’s discounted cash flows. There are three steps in the bond valuation process:  Estimate the cash flow. For a bond, there are two types of cash flows: (1) the annual or semiannual coupon payments and (2) the recovery of principal at maturity, or when the bond is retired.  Determine the appropriate discount rate. The approximate discount rate is either the bond’s yield to maturity (TYM) or a series of spot rates.  Calculate the PV of the estimated cash flows. In this topic, the concentration is on bonds that pay coupons semiannually in even 6-month from settlement. PRICE QUOTATIONS  Bonds are quoted on a percentage basis relative to a par value.  Treasury notes and bonds use a “32nds” convention.  A “+” in the quote indicates a half tick.  Corporate and municipal bonds are quoted in eighths. 1 謝承熹 DISCOUNT FACTORS AIM 2: Define discount factor and use a discount function to compute present and future values. The discount factor for a particular term gives the value today, or the present value of one unit of currency to be received at the end of that term. 2 謝承熹 DETERMINING VALUE USING DISCOUNT FUNCTIONS AIM 3: Define the “law of one p