Chapter 4 Valuing Bonds . Professor Thomson Fin 3013. Quote from Gyourko (UPenn).
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From Knowledge at Wharton
The U.S bond market has grown from $250 billion in 1950 to $22 trillion in 2004
Example 4.3: Consider 2 Bonds
A: 7% Bond with 28 years to maturity
B: 7% Bond with 4 years to maturity
Compute the market price of these bonds as the market rate changes from 3-10%
(1+NR) = (1+IN)*(1+RR)
NR = IN+RR
What do you think a Yield Curve would look like
Corporate prices are quoted as percentage of par, without the 32nds of a dollar quoting convention
Yield spread:the difference in yield-to-maturities between a corporate bond and a Treasury bond with same maturity
The greater the default risk, the higher
the yield spread
Coupon rate of 5.5%
Yield to maturity on the ask price
Bid price:the price traders receive if they sell a bond to the dealer. Quoted in increments of 32nds of a dollar
(percentage of par value)
Ask price:the price traders pay to the dealer to buy a bond
Bid-ask spread: difference between ask and bid prices.U.S. Treasury Bond Quotations
This model can express the price of any asset at
t = 0 mathematically.
Estimate of return investors earn if they buy
the bond at P0 and hold it until maturity
The YTM on a bond selling at par will always equal
the coupon rate.
YTM is the discount rate that equates the
PV of a bond’s cash flows with its price.
Time to maturity: bond prices converge to par value (plus final coupon) with passage of time.
Interest rates: bond prices and interest rates move in opposite directions.
Changes in interest rates have larger impact on long-term bonds than on short-term bonds.
What does this tell you about the relationship
between bond prices and yields for bonds with
Primary market: the initial sale of bonds by issuers to large investors or syndicates
Secondary market: the market in which investors trade with each other
Trades in the secondary market do not raise any capital for issuing firms.
Fixed vs. Floating Rates
Secured vs. Unsecured BondsBonds by Features
Convertible and Exchangeable Bonds
Callable and Putable Bonds
Protection from Default RiskBonds by Features (Continued)
Bond price equals present value of its coupons and principal.
Bond prices are inversely related to interest rates.
Bonds could have a number of features: such as convertibility, callability.