bond,importance and characteristics.pptx

Bond and its importance

1. Bonds and Their Valuation

2. Bonds are simply long-term IOUs that represent claims against a firm’s assets. Bonds are a form of debt Bonds are often referred to as fixed -income investments. Bond Basics

3. Key Features of a Bond Debt instrument issued by a corp. or government. Par value = face amount of the bond, which is paid at maturity (assume $1,000). Maturity date – when the bond must be repaid. Yield to maturity - rate of return earned on a bond held until maturity. Coupon rate – stated interest rate (generally fixed) paid by the issuer. Multiply by par to get dollar payment of interest.

4. Bond Value Bond Value = PV(coupons) + PV(par) Bond Value = PV(annuity) + PV(lump sum)

5. Bond Valuation 1. Compute the value for an IBM Bond with a 6.375% coupon that will mature in 5 years given that you require an 8% return on your investment.

6. 0 1 2 3 4 5 2009 2010 2011 2012 2013 63.75 63.75 63.75 63.75 63.75 1,000.00 IBM Bond Timeline:

7. $63.75 Annuity for 5 years $1000 Lump Sum in 5 years 0 1 2 3 4 5 2009 2010 2011 2012 2013 63.75 63.75 63.75 63.75 63.75 1000.00 IBM Bond Timeline:

8. = 63.75 PMT , 1000 FV , 8% I , 5 N = PV = 935.12 $63.75 Annuity for 5 years $1000 Lump Sum in 5 years 0 1 2 3 4 5 2009 2010 2011 2012 2013 63.75 63.75 63.75 63.75 63.75 1000.00 IBM Bond Timeline:

9. Semi -Annual Bonds: Most Bonds Pay Interest Semi-Annually: What is the value of a bond with a semi-annual coupon with 5 years to maturity, 9% (nominal) coupon rate if an investor desires a 10% (nominal) return?

10. Most Bonds Pay Interest Semi-Annually: e.g. semiannual coupon bond with 5 years to maturity, 9% annual coupon rate. Instead of 5 annual payments of $90, the bondholder receives 10 semiannual payments of $45. 0 1 2 3 4 5 2013 2014 2015 2016 2017 45 45.00 1000.00 45 45 45 45 45 45 45 45

11. Compute the value of the bond given that you require a 10% s-a. return on your investment. Since interest is received every 6 months, we need to use semiannual compounding V B = 45 - PMT 1000 - FV 5% - I 10 - N Most Bonds Pay Interest Semi-Annually: 0 1 2 3 4 5 2013 2014 2015 2016 2017 45 45.00 1000.00 45 45 45 45 45 45 45 45

12. Most Bonds Pay Interest Semi-Annually: = PV = 961.39 Compute the value of the bond given that you require a 10% s-a. return on your investment. Since interest is received every 6 months, we need to use semiannual compounding 0 1 2 3 4 5 2013 2014 2015 2016 2017 45 45 1,000 45 45 45 45 45 45 45 45

13. Semiannual Bonds Ex 2 Coupon rate = 14% - Semiannual YTM = 16% (APR) Maturity = 7 years Value of bond? Number of coupon payments? (2t or N) 14 = 2 x 7 years Semiannual coupon payment? (C/2 or PMT) $70 = (14% x Face Value)/2 Semiannual yield? (YTM/2 or I/Y) 8% = 16%/2

14. Semiannual Bonds Semiannual coupon = $70 Semiannual yield = 8% Periods to maturity = 14 Bond value = 70[1 – 1/(1.08) 14 ] / .08 + 1000 / (1.08) 14 = 917.56 Using the calculator : 14 N 8 I/Y 70 PMT 1000 FV CPT PV = -917.56 Using Excel: =PV(0.08, 14, 70, 1000, 0)

15. If bond Sells at a DISCOUNT (less than $1,000) then YTM > Coupon Rate If bond Sells at a PREMIUM (more than $1,000) then YTM < Coupon Rate Yield to Maturity -1,000 1 2 3 4 5 2013 2014 2015 2016 2017 80 80 80 80 80 1,000

16. Valuing a Discount Bond with Annual Coupons Coupon rate = 10% Annual coupons Par = $1,000 Maturity = 5 years YTM = 11% Price= ?

17. Valuing a Discount Bond with Annual Coupons Coupon rate = 10% Annual coupons Par = $1,000 Maturity = 5 years YTM = 11% Using the formula: B = PV(annuity) + PV(lump sum) B = 369.59 + 593.45 = 963.04 Using the calculator : 5 N 11 I/Y 100 PMT 1000 FV CPT PV = -963.04 Note: When YTM > Coupon rate  Price < Par = “Discount Bond” Using Excel: =PV(0.11, 5, 100, 1000, 0)

18. Valuing a Premium Bond with Annual Coupons Coupon rate = 10% Annual coupons Par = $1,000 Maturity = 20 years YTM = 8% Price = ?

19. Valuing a Premium Bond with Annual Coupons Coupon rate = 10% Annual coupons Par = $1,000 Maturity = 20 years YTM = 8% Using the formula: B = PV(annuity) + PV(lump sum) B = 981.81 + 214.55 = 1196.36 Note: When YTM < Coupon rate  Price > Par = “Premium Bond” Using the calculator : 20 N 8 I/Y 100 PMT 1000 FV CPT PV = -1196.36 Using Excel: =PV(0.08, 20, 100, 1000, 0)

20. Yield to Maturity If an investor purchases a 6.375% annual coupon bond today for $900 and holds it until maturity (5 years), what is the expected annual rate of return (YTM)? -900 ?? 0 1 2 3 4 5 2013 2014 2015 2016 2017 63.75 63.75 63.75 63.75 63.75 1000.00 + ?? 900

21. Yield to Maturity 63.75 =PMT 1000= FV 5= N -900 =PV I = ? YTM?? If an investor purchases a 6.375% annual coupon bond today for $900 and holds it until maturity (5 years), what is the expected annual rate of return ? Will it be >< than 6.375%? 0 1 2 3 4 5 2013 2014 2015 2016 2017 63.75 63.75 63.75 63.75 63.75 1000.00

22. What’s the YTM on a 10-year, 9% annual coupon, $1,000 par value bond that sells for $887? 90 90 90 1 9 10 r d =? 1,000 PV 1 . . . PV 10 PV M 887 Find r d that “works”! ...

23. 10 -887 90 1000 N I/YR PV PMT FV 10.91 INPUTS OUTPUT