Derivatives
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Derivatives. Lecture 7. Bond Prices. Example If today is October 2001, what is the value of the following bond? An IBM Bond pays $115 every Sept for 5 years. In Sept 2006 it pays an additional $1000 and retires the bond. The bond is rated AAA (WSJ AAA YTM is 7.5%) Cash Flows

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Derivatives

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Derivatives

Derivatives

Lecture 7


Bond prices

Bond Prices

Example

If today is October 2001, what is the value of the following bond?

An IBM Bond pays $115 every Sept for 5 years. In Sept 2006 it pays an additional $1000 and retires the bond.

The bond is rated AAA (WSJ AAA YTM is 7.5%)

Cash Flows

Sept 0203040506

1151151151151115


Bond prices1

Bond Prices

Example continued

If today is October 2001, what is the value of the following bond?

An IBM Bond pays $115 every Sept for 5 years. In Sept 2006 it pays an additional $1000 and retires the bond.

The bond is rated AAA (WSJ AAA YTM is 7.5%)


Bond prices yields

Bond Prices & Yields

Price

Yield


Yield to maturity

Yield To Maturity

All interest bearing instruments are priced to fit the term structure

This is accomplished by modifying the asset price

The modified price creates a New Yield, which fits the Term Structure

The new yield is called the Yield To Maturity (YTM)


Yield to maturity1

Yield to Maturity

Example

A $1000 treasury bond expires in 5 years. It pays a coupon rate of 10.5%. If the market price of this bond is 107.88, what is the YTM?


Yield to maturity2

Yield to Maturity

Example

A $1000 treasury bond expires in 5 years. It pays a coupon rate of 10.5%. If the market price of this bond is 107.88, what is the YTM?

C0C1C2C3C4C5

-1078.801051051051051105

Calculate IRR = 8.5%


Bond prices yields1

Bond Prices & Yields

Price

Yield


Bond price sensitivity

Bond Price Sensitivity

Bond B

YTM = 3.50%

Maturity = 5 years

Coupon = 7% or $70

Par Value = $1,000

Price = $1,158.03

Bond A

YTM = 4.00%

Maturity = 8 years

Coupon = 6% or $60

Par Value = $1,000

Price = $1,134.65


Bond price sensitivity1

Bond Price Sensitivity

Bond B

YTM = 4.25%

Maturity = 5 years

Coupon = 7% or $70

Par Value = $1,000

New Price =$1,121.57

Price dropped by 3.15 %

Bond A

YTM = 4.75%

Maturity = 8 years

Coupon = 6% or $60

Par Value = $1,000

New Price= $1,108.61

Price dropped by 2.30 %

Yields increased 0.75%...prices dropped differently


Problems

Problems

  • Class examples

    Homework

    FinCoach

  • 5 Bond price problems

  • 5 Bond YTM problems


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