CHAPTER 9 BONDS AND THEIR VALUATION

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CHAPTER 9 BONDS AND THEIR VALUATION by Mind Map: CHAPTER 9 BONDS 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”).

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)