1
Chapter 7
Valuation and
Characteristics of Bonds
General Valuation: The following
comments are valid for all kind of
assets.
3
Book Value
Stated value from the firm’s Balance Sheet
Market Value
The price for the asset at any given time--determined
by supply and demand in the marketplace. Asset can
be bought or sold at this price.
Intrinsic Value
Present value of the asset’s expected cash flow
Investor estimates cash flows
Investor determines required rate based on risk of
asset and market conditions.
4
In a perfect market where all investors have the
same expectations & risk aversion:
Market Value = Intrinsic Value
Bonds
 Debt Instruments
 Bondholders are lending to the corporation (or, governments)
money for some stated period of time.
 Liquid Asset
 Corporate Bonds can be traded in the secondary market.
 Price at which a given bond trades is determined by market
conditions and terms of the bond.
5
Bond Terminology
6
Par Value
Usually $1,000. Also called the Face Value
Coupon Interest Rate
Borrowers (firms) typically make periodic payments to
the bondholders. Coupon rate is the percent of face
value paid every year.
Maturity
Time at which the maturity value (Par Value) is paid to
the bondholder.
Indenture
Document which details the legal obligation of the
corporation to the bondholders. The indenture lists all
the terms and conditions of the bond.
Types of Bonds
Debentures
Subordinated Debenture
Mortgage Bond
Eurobond
Convertible Bond
Zero Coupon Bonds
Junk Bond
7
8
Bond Ratings
 Moody’s and Standard & Poors regularly monitor issuers’
financial conditions and assign a rating to the debt. Bond
rating shows the relative probability of default.
similar to a personal credit report
Investment
Grade
Junk
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Top Quality
Low Quality
No interest being paid
Currently in Default
9
Bond Ratings
Bond Ratings can change due to many factors.
Caterpillar Corp debt was recently upgraded due to
fact that it appears that current 10 month strike has
not affected prospects of firm in any significant
manner.
Corporate Bond Ratings
Citicorp
AGMAC
BBB+
Bell South
AAA
DuPont
AAPhillip Morris
A
Kroger
BB+
Unisys
BBBethlehem Steel
B+
Grand Union
D
10
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Company Issuing the Bond
11
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Coupon Interest Rate
12
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Coupon Interest Rate
Determines the Investor’s Periodic Cash Flow
13
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Coupon Interest Rate
Determines the Investor’s Periodic Cash Flow
Cash Flow = Interest Payment = Coupon Rate x Par
= .06375 x 1000 = $63.75/Year
14
Bond Quotes
Cur
Yld
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Year of Maturity
15
Bond Quotes
Cur
Yld
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Year of Maturity
Determines the Time frame for the Investment
00 = year 2000, therefore in 1995 this is a 5 year investment
16
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Current Yield (%)
17
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Current Yield (%)
Anuual $ Coupon
63.75
=
= .066 = 6.6%
Current Yield =
Market Price
966.25
18
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Daily Trading Volume
19
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Daily Closing Market Price
20
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Daily Closing Market Price
Expressed as a % of Par
21
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Daily Closing Market Price
Expressed as a % of Par
$Price = 965/8 x 10 = $966.25
22
Bond Quotes
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Change from Previous Day’s Closing Price
Bond Valuation Model
23
Bond Valuation is an application of Present Value.
The Value of the bond is the present value of all the
cash flows the investor receives as a result of
holding the bond.
3 Cash Flows
Amount that is paid to purchase the bond (PV)
Periodic Interest Payments made to the bondholders
(PMT)
Payment of maturity value at end of Bond’s life.
Other Terminology
Time frame for cash flows (N) = Bond’s Maturity
 Interest Rate for Time Value is the rate at which
future cash flows are being discounted to present.
24
Bond Valuation Model
IBM Bond Timeline:
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Cur
Yld
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Investor that purchases bond today (1995) for $966.25 will receive 5
annual interest payments of $63.75 and a $1,000 payment in 5 years.
25
Bond Valuation Model
IBM Bond Timeline:
Cur
Yld
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
Investor that purchases bond today (1995) for $966.25 will receive 5
annual interest payments of $63.75 and a $1,000 payment in 5 years.
1995
1996
1997
1998
1999
0
1
2
3
4
63.75
63.75
63.75
63.75
2000
5
63.75
1000.00
26
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
1999
2000
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
27
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$59.03
$63.75
(1.08)
1999
2000
Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
28
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$59.03
$54.66
$63.75
(1.08)2
1999
2000
Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
29
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$59.03
$54.66
$50.61
1999
2000
$63.75
(1.08)3
Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
30
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$59.03
$54.66
$50.61
$46.86
1999
2000
$63.75
(1.08)4
Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
31
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$59.03
$54.66
$50.61
$46.86
$43.39
1999
2000
$63.75
(1.08) 5
Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
32
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$59.03
$54.66
$50.61
$46.86
$43.39
$680.58
$935.12
1999
2000
$1000
(1.08) 5
Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
33
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$63.75 Annuity for 5 years
1999
2000
34
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
1999
2000
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
35
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
1999
2000
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
Vb = I(PV of Annuity) + PV of Par
37
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
1999
2000
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
Vb = I(PV of Annuity) + PV of Par
= 63.75( 1
.08
1
1000
)
+
5
5
.08(1+.08)
(1+.08)
38
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
1999
2000
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
Vb = I(PV of Annuity) + PV of Par
= 63.75( 1
.08
1
1000
)
+
5
5
.08(1+.08)
(1+.08)
= 63.75(3.9927) + 680.58
39
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995
1996
1997
1998
1999
2000
0
1
2
3
4
5
63.75
63.75
63.75
63.75
63.75
1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
Vb = I(PV of Annuity) + PV of Par
= 63.75( 1
.08
1
1000
)
+
5
5
.08(1+.08)
(1+.08)
= 63.75(3.9927) + 680.58
= 254.54 + 680.58 = 935.12
40
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
Cur
Yld
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
1995
1996
1997
1998
0
1
2
3
45
45
45
45
45
45
1999
4
45
45.00
1000.00
2000
5
41
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
Cur
Yld
Bonds
AMR6¼24
ATT 8.35s25
IBM 63/8 00
Kroger 9s99
Vol
cv
6
8.3 110
6.6 228
8.8
74
Close
Net
Chg
91¼
102¾
965/8
1017/8
-1½
+¼
-1/8
-¼
Source: Wall Street Journal
1995
1996
1997
1998
0
1
2
3
45
45
45
45
45
45
1999
4
45
2000
5
45.00
1000.00
Rather than receiving 4 annual payments of $90, the
bondholder will receive 4x2 = 8 semiannual payments
of 90÷2=$45.
42
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995
1996
1997
1998
0
1
2
3
45
45
45
45
45
45
1999
4
45
2000
5
45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
43
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995
1996
1997
1998
0
1
2
3
45
45
45
45
45
45
1999
4
45
2000
5
45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
Since interest is received every 6 months, need to use
semi-annual compounding
44
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995
1996
1997
1998
0
1
2
3
45
45
45
45
45
45
1999
4
45
2000
5
45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
Since interest is received every 6 months, need to use
semi-annual compounding
1
Vb = 45( .05
Semi-Annual
Compounding
1
1000
8) +
8
.05(1+.05)
(1+.05)
10%
2
45
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995
1996
1997
1998
0
1
2
3
45
45
45
45
45
45
1999
4
45
2000
5
45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
Since interest is received every 6 months, need to use
semi-annual compounding
1
Vb = 45( .05
1
1000
8) +
8
.05(1+.05)
(1+.05)
=45(6.4632) + 676.84
46
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995
1996
1997
1998
0
1
2
3
45
45
45
45
45
45
1999
4
45
2000
5
45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
Since interest is received every 6 months, need to use
semi-annual compounding
1
Vb = 45( .05
1
1000
8) +
8
.05(1+.05)
(1+.05)
=45(6.4632) + 676.84
= 290.85 + 676.84 = 967.68
Yield to Maturity
Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
47
Yield to Maturity
Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
Substitute the Market Price (P0) for Vb and
solve for kb where kb = Annual YTM
1

1
Par
P0   

n
n
k
 b k b (1  k b )  (1  k b )
48
49
Yield to Maturity
Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
Substitute the Market Price (P0) for Vb and
solve for kb where kb = Annual YTM
1

1
Par
P0   

n
n
k
 b k b (1  k b )  (1  k b )
Cannot Solve
Directly
50
Yield to Maturity
Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
IBM Corporate Bond:
1995
1996
1997
1998
1999
0
1
2
3
4
-966.25
63.75
63.75
63.75
63.75
2000
5
63.75
1000.00
51
Yield to Maturity
Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
IBM Corporate Bond:
1995
1996
1997
1998
0
1
2
3
4
-966.25
63.75
63.75
63.75
63.75
??
+ ??
966.25
1999
2000
5
63.75
1000.00
52
Yield to Maturity
Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
IBM Corporate Bond:
1995
1996
1997
1998
0
1
2
3
4
-966.25
63.75
63.75
63.75
63.75
??
+ ??
966.25
1999
2000
5
63.75
1000.00
53
Yield to Maturity
Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
IBM Corporate Bond:
1995
1996
1997
1998
1999
0
1
2
3
4
-966.25
63.75
63.75
63.75
63.75
??
+ ??
966.25
1

1
1000
966.25  63.75 

5
 k b (1  k b )  (1  k b ) 5
2000
5
63.75
1000.00
Yield to Maturity
1

1
1000
966.25  63.75 

5
 k b (1  k b )  (1  k b ) 5
Cannot Solve directly, must use a Financial Calculator
or the following Approximation Formula for YTM:
54
55
Yield to Maturity
1

1
1000
966.25  63.75 

5
 k b (1  k b )  (1  k b ) 5
Cannot Solve directly, must use a Financial Calculator
or the following Approximation Formula for YTM:
YTM Approximation Formula
1000  Po

n
kb 
1000  2 P0
3
56
Yield to Maturity
IBM Corporate Bond:
1995
1996
1997
1998
0
1
2
3
4
-966.25
63.75
63.75
63.75
63.75
YTM Approximation Formula
1000  Po

n
kb 
1000  2 P0
3
1999
2000
5
63.75
1000.00
57
Yield to Maturity
IBM Corporate Bond:
1995
1996
1997
1998
0
1
2
3
4
-966.25
63.75
63.75
63.75
63.75
YTM Approximation Formula
1000  Po

n
kb 
1000  2 P0
3
1999
2000
5
63.75
1000.00
1000  966.25
63.75 
5

1000  2(966.25)
3
58
Yield to Maturity
IBM Corporate Bond:
1995
1996
1997
1998
0
1
2
3
4
-966.25
63.75
63.75
63.75
63.75
YTM Approximation Formula
1000  Po

n
kb 
1000  2 P0
3
1999
2000
5
63.75
1000.00
1000  966.25
63.75 
5

1000  2(966.25)
3

70.50

7.21%
977.50
59
Interest Rate Risk
Bond Prices fluctuate over Time
As interest rates in the economy change, required
rates on bonds will also change resulting in investor’s
intrinsic values changing and market prices changing.
Interest
Rates
Vb
60
Interest Rate Risk
Bond Prices fluctuate over Time
As interest rates in the economy change, required
rates on bonds will also change resulting in investor’s
intrinsic values changing and market prices changing.
Interest
Rates
Interest
Rates
Vb
Vb
Interest Rate Risk
Bond Prices fluctuate over Time
61
Interest Rate Risk
62
Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is
set to match current prevailing rates.
Interest Rate Risk
63
Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is
set to match current prevailing rates.
Over time, the prevailing rates may change, but the
coupon rate is fixed.
Interest Rate Risk
64
Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is
set to match current prevailing rates.
Over time, the prevailing rates may change, but the
coupon rate is fixed.
Resulting in the actual price of the bond changing.
Interest Rate Risk
65
Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is
set to match current prevailing rates.
Over time, the prevailing rates may change, but the
coupon rate is fixed.
Resulting in the actual price of the bond changing.
1995
AAA Bonds are currently yielding 6%
Purchase ATT 6s2015 Bond for $1000.00
Interest Rate Risk
66
Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is
set to match current prevailing rates.
Over time, the prevailing rates may change, but the
coupon rate is fixed.
Resulting in the actual price of the bond changing.
1995
AAA Bonds are currently yielding 6%
Purchase ATT 6s2015 Bond for $1000.00
1
1
1000
Vb = 60( .06 .06(1+.06)20 ) + (1+.06)20
= $1,000
Interest Rate Risk
1995
AAA Bonds are currently yielding 6%
Purchase ATT 6s2015 Bond for $1000.00
1998
AAA Bonds are currently yielding 9%
If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
67
Interest Rate Risk
1995
AAA Bonds are currently yielding 6%
Purchase ATT 6s2015 Bond for $1000.00
1998
AAA Bonds are currently yielding 9%
If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
1
1
1000
Vb = 60( .09 .09(1+.09)17 ) + (1+.09)17
= $743.69
68
Interest Rate Risk
1995
AAA Bonds are currently yielding 6%
Purchase ATT 6s2015 Bond for $1000.00
1998
AAA Bonds are currently yielding 9%
If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
Market Price for ATT6s2015 is now $743.69
2001
AAA Bonds are currently yielding 5%
If you want to sell the the ATT 6s2015
Bond, it must be priced to earn the
purchaser a competitive rate (required
rate = 5%)
69
Interest Rate Risk
1995
AAA Bonds are currently yielding 6%
Purchase ATT 6s2015 Bond for $1000.00
1998
AAA Bonds are currently yielding 9%
If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
Market Price for ATT6s2015 is now $743.69
2001
AAA Bonds are currently yielding 5%
If you want to sell the the ATT 6s2015
Bond, it must be priced to earn the
purchaser a competitive rate (required
rate = 5%)
1000
1
1
Vb = 60(.05 .05(1+.05)14) + (1+.05)14 = $1,098.99
70
71
Interest Rate Risk
1995
AAA Bonds are currently yielding 6%
Purchase ATT 6s2015 Bond for $1000.00
1998
AAA Bonds are currently yielding 9%
If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
Market Price for ATT6s2015 is now $743.69
2001
AAA Bonds are currently yielding 5%
If you want to sell the the ATT 6s2015
Bond, it must be priced to earn the
purchaser a competitive rate (required
rate = 5%)
Market Price for ATT6s2015 is now
$1,098.99
Bond Prices fall during
periods of rising interest
rates and rise during
periods of falling interest
rates.
Bond Relationships
Bond Price changes in the opposite direction of the
interest rate changes
73
Bond Relationships
74
Bond Price changes in the opposite direction of the
interest rate changes
If the coupon rate of a bond is less than the required
rate of investors, the bond will sell at a discount. Fig.
7-3.
As the maturity date approaches, the market value of
the bond approaches its par value. Fig 7-4, Table 72.
Everything else being equal, a bond with longer
maturity is more price sensitive to changes in interest
rates than a bond with shorter maturity.
Bond Relationships
75
Bond Price changes in the opposite direction of the
interest rate changes.
If the coupon rate of a bond is less than the required
rate of investors, the bond will sell at a discount. Fig.
7-3.
As the maturity date approaches, the market value of
the bond approaches its par value. Fig 7-4, Table 72.
Everything else being equal, a bond with longer
maturity is more price sensitive to changes in interest
rates than a bond with shorter maturity.
Everything else being equal, a bond with higher
coupon is less price sensitive to changes in interest
rates than a bond with lower coupon.
76