bond valuation l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Bond Valuation PowerPoint Presentation
Download Presentation
Bond Valuation

Loading in 2 Seconds...

play fullscreen
1 / 20

Bond Valuation - PowerPoint PPT Presentation


  • 147 Views
  • Uploaded on

Bond Valuation. Economics 71a: Spring 2007 Mayo Chapter 13 Lecture notes 4.4. Goals. Easy valuation Present values Yield Yield to maturity Difficult issues Interest rates Defaults Call options. Present Values and Bonds. Bond example: Par = 1000 Coupon = 5% = $50 (per year)

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Bond Valuation' - ostinmannual


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
bond valuation

Bond Valuation

Economics 71a: Spring 2007

Mayo Chapter 13

Lecture notes 4.4

goals
Goals
  • Easy valuation
    • Present values
    • Yield
    • Yield to maturity
  • Difficult issues
    • Interest rates
    • Defaults
    • Call options
present values and bonds
Present Values and Bonds
  • Bond example:
    • Par = 1000
    • Coupon = 5% = $50 (per year)
    • Required return, k = 7%
    • Maturity = 3 years
bond pricing
Bond Pricing
  • Bonds trade at a given price
  • May be above or below your valuation
  • Strategy
    • Buy if price < present value
    • Sell if price > present value
yield
Yield
  • Interest/Price
  • Example
    • Par = 1000
    • Coupon = 5%
    • Current price = 900
    • Yield = 50/900 = 5.56%
yield to maturity
Yield to Maturity
  • Required return to get get PV = Price
  • Similar to internal rate of return
  • Requires computer
semiannual interest pays every 6 months
Semiannual InterestPays every 6 months
  • Par = 1000
  • Coupon = 5%, pays (1/2)50 = 25 every 6 months
  • Maturity = 3 years
  • k = 8% (k per 6 months = 4%)
goals11
Goals
  • Easy valuation
    • Present values
    • Yield
    • Yield to maturity
  • Difficult issues
    • Interest rates
    • Defaults
    • Call
interest rates
Interest Rates
  • k = RF + RP
  • RF = risk free rate
  • RF rises
    • Bond price falls
  • RF falls
    • Bond price rises
  • Sensitivity to interest changes = “Duration”
bond prices and duration
Bond Prices and Duration
  • Two bonds: 1 and 5 year zero coupon
  • RP = 0 (government bond)
  • Interest rate change 3% to 5%
  • 1 year bond
    • Price = 970.87 -> 952.38
  • 5 year bond
    • Price = 862.61 -> 783.53
  • Longer maturity leads to more interest sensitivity
the term structure
The Term Structure
  • Different rates for different horizons
    • 6 month
    • 1 year
    • 2 years
    • 5 years
    • 10 years
    • 30 years
yield curve
Yield Curve

Interest Rate

Annual %

5%

1 2 5 10 20

Years into future

Time of maturity

the yield curve
The Yield Curve
  • The yield curve changes over time
  • See “The living yield curve” website
  • Inverted yield curves
  • The yield curve and GDP
defaults
Defaults
  • When bond defaults, investors get firm assets (likely zero)
  • Probability related to bond rating
  • Risk premium increases with probability of default
  • k = RF + RP
    • Higher default probability
    • Higher RP
    • Lower price
call option
Call Option
  • Definition
    • Option that lets firm buy back bond
    • Get paid par + some percentage
    • Shuts down bond investment
  • Similar to refinancing
  • Depends on interest movements
  • Impacts price, but difficult to value
final thoughts on bonds
Final Thoughts on Bonds
  • Stable income streams
  • Easier to evaluate than stocks
    • More structure
    • Fewer hunches
  • Easier for sophisticated professionals to have an edge
  • Stocks are more guesswork