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Pricing of Bonds - PowerPoint PPT Presentation
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Pricing of Bonds. Chapter 2. Time of Value. Future Value where: n = number of periods P n = future value n periods from now (in dollars) P o = original principal (in dollars) r = interest rate per period (in decimal form) Future Value of on Ordinary Annuity.
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Presentation Transcript
Pricing of Bonds
Chapter 2
Time of Value
- Future Value
where:
n = number of periods
Pn = future value n periods from now (in dollars)
Po = original principal (in dollars)
r = interest rate per period (in decimal form)
- Future Value of on Ordinary Annuity
Time Value of Money
- Present Value
- Present Value of a Series of Future Values
Time Value of Money
- Present Value of an Ordinary Annuity
Bond Pricing
- price = PV of all future cash flows
- to find price, you need
- expected CFs
- coupon payments
- par value
- yield
Bond Pricing
- price – yield relationship
- inverse because as yield falls, PV of CFs increases and price of bond increases
- price-yield curve is convex for noncallable bonds
- discount / premium to par when coupon rate < / > required yield
- market price changes when
- yield changes due to credit quality of issuer
- change in price of bond selling at discount/premium because getting closer to maturity
- change in yield required by market for bonds of similar risk
Bond Pricing
- floater – security that has coupon rate that changes when market rates change
- coupon = reference rate plus spread
- reset periodically
- cap / floor
- inverse floater
- created using a fixed rate bond (collateral)
- create floater and inverse floater so that
- total coupon interest paid to two bonds in each period is less than or equal to collateral’s coupon interest in each period
- total par value of two bonds is less than or equal to collateral’s total par value
- ie., two securities created so that CFs from collateral can satisfy obligation of floater and inverse floater
