Derivatives

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# Derivatives - PowerPoint PPT Presentation

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

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

Sept 02 03 04 05 06

115 115 115 115 1115

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%)

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 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 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?

C0 C1 C2 C3 C4 C5

-1078.80 105 105 105 105 1105

Calculate IRR = 8.5%

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 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
• Class examples

Homework

FinCoach

• 5 Bond price problems
• 5 Bond YTM problems