CHAPTER 4 BONDS features AND THEIR VALUATION

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CHAPTER 4 BONDS features AND THEIR VALUATION by Mind Map: CHAPTER 4 BONDS features AND THEIR VALUATION

1. WHAT IS BOND?

1.1. A long-term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the holders of the bond.

2. BOND FEATURES

2.1. Par Value - the face value of a bond

2.2. Coupon Interest Rate - the specified number of dollars of interest paid each year

2.3. Maturity Date - a specified date on which the par value of a bond must be repaid.

2.4. Issue date – when the bond was issued.

2.5. Yield to maturity (YTM)- rate of return earned on a bond held until maturity (also called the “promised yield”).

3. BOND VALUATION

3.1. (Par Bond)

3.1.1. rd = coupon rate, fixed-rate bond sells at par

3.2. (Discount Bond)

3.2.1. rd > coupon rate, fixed-rate bond sells below par

3.3. (Premium Bond)

3.3.1. rd < coupon rate, fixed-rate bond sells above par

4. BOND PRICING

4.1. clean price

4.1.1. =full price- accured interest

4.2. FULL PRICE

4.2.1. the rate of return earned on a bond when it is called before its maturity date.

4.2.2. compute price at the date of last coupon payment before transaction

4.2.2.1. In general, if a bond sells at a premium, then

4.2.2.1.1. 1) coupon > rd

4.2.2.1.2. 2) a call is more likely

4.2.3. full price =price before transaction*(1+rd)^t/T

4.2.4. compute n° of days

4.2.4.1. t=between last coupon and transaction dates

4.2.4.2. T=In a period

5. SEMIANNUAL BOND

5.1. STEPS :)

5.1.1. 1) Multiply years by 2 : number of periods = 2n.

5.1.2. 2) Divide nominal rate by 2 : periodic rate (I/YR) = rd / 2.

5.1.3. 3) Divide annual coupon by 2 : PMT = ann cpn / 2.

5.2. Annual VS Semiannual

5.2.1. (Semiannual effective rate) > (the annual bond’s effective rate)

5.2.1.1. so you would prefer the semiannual bond.

6. CHANGES IN BOND VALUES OVER TIME

6.1. At maturity, the value of any bond must equal its par value.

6.2. current yield (CY)= Annual Coupon Payment / Current Payment

6.3. Capital Gains Yield(CGY) = Change in Price / Beginning Price

6.4. Expected Total Return = YTM = (Expected CY) + ( Expected CGY)