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### Transcript of Chap006 NC

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Chapter 6

Interest Rates andBond Valuation

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Key Concepts and Skills Know the important bond features and

bond types Understand bond values and why they

fluctuate

Understand bond ratings and what theymean

Understand the impact of inflation on

interest rates Understand the term structure of interest

rates and the determinants of bond yields

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Chapter Outline

Bonds and Bond Valuation

More on Bond Features

Bond Ratings Some Different Types of Bonds

Bond Markets

Inflation and Interest Rates Determinants of Bond Yields

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Bond Definitions

Bond

Par value (face value)

Coupon rate Coupon payment

Maturity date

Yield or Yield to maturity

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PV of Cash Flows as RatesChange

Bond Value = PV of coupons + PV of par

Bond Value = PV annuity + PV of lumpsum

Remember, as interest rates increase, thePVs decrease

So, as interest rates increase, bond pricesdecrease, and vice versa

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Valuing a Discount Bond withAnnual Coupons

Consider a bond with a coupon rate of 10%and coupons paid annually. The par valueis \$1,000 and the bond has 5 years tomaturity. The yield to maturity is 11%.

What is the value of the bond?

Using the formula:

B = PV of annuity + PV of lump sum

B = \$100[1 1/(1.11)5] / .11 + \$1,000 /(1.11)5

B = \$369.59 + 593.45 = \$963.04

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Valuing a Premium Bond withAnnual Coupons

Suppose you are looking at a bond thathas a 10% annual coupon and a facevalue of \$1,000. There are 20 years tomaturity and the yield to maturity is 8%.What is the price of this bond?

Using the formula:

B = PV of annuity + PV of lump sum

B = \$100[1 1/(1.08)20] / .08 + \$1,000 /(1.08)20

B = \$981.81 + 214.55 = \$1,196.36

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Graphical Relationship BetweenPrice and YTM

600

700

800

900

1000

1100

1200

1300

1400

1500

0% 2% 4% 6% 8% 10% 12% 14%

YTM

Price

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Bond Prices: RelationshipBetween Coupon and Yield

If YTM = coupon rate, then par value =bond price

If YTM > coupon rate, then par value >bond price Why?

Price below par = discount bond

If YTM < coupon rate, then par value