## CHAPTER 9 BONDS AND THEIR VALUATION

by nor fazrina
## 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”).

### 2.6. Yield to call (YTC) - rate of return earned on a bond when it is called before its maturity date.

### 2.7. Call Provision - a provision in a bond contract that gives the issuer a right o redeem the bonds under specified terms prior to the normal maturity date.

## 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 YIELDS

### 4.1. Yield to Maturity

4.1.1. the rate of return earned on a bond if it is held to maturity

### 4.2. Yield to Call

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

4.2.2. -> Sells at Premium

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. -> Sells at Discount

4.2.4. Expected to Earned

4.2.4.1. YTC on premium bond

4.2.4.2. YTM on par and discount bonds

## 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)