Slide 1Chapter OutlineLearning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives6.1 Bond Cash Flows, Prices, and Yields6.1 Bond Cash Flows, Prices, and Yields (continued)Zero-Coupon BondsZero-Coupon Bonds (continued)Zero-Coupon Bonds (cont'd)Zero-Coupon Bonds (continued)Zero-Coupon Bonds (continued)Textbook Example 6.1Textbook Example 6.1 (continued)Alternative Example 6.1Alternative Example 6.1 (continued)Zero-Coupon Bonds (continued)Coupon BondsTextbook Example 6.2Textbook Example 6.2 (continued)Alternative Example 6.2Alternative Example 6.2 (continued)Coupon Bonds (continued)Textbook Example 6.3Textbook Example 6.3 (continued)Financial Calculator SolutionAlternative Example 6.3Alternative Example 6.3Textbook Example 6.4Textbook Example 6.4 (cont'd)Financial Calculator SolutionAlternative Example 6.4Alternative Example 6.46.2 Dynamic Behavior of Bond PricesDiscounts and PremiumsDiscounts and Premiums (continued)Discounts and Premiums (continued)Textbook Example 6.5Textbook Example 6.5 (continued)Financial Calculator SolutionFinancial Calculator Solution (cont'd)Financial Calculator Solution (cont'd)Time and Bond PricesTextbook Example 6.6Textbook Example 6.6 (continued)Textbook Example 6.6 (continued)Financial Calculator SolutionFinancial Calculator Solution (cont'd)Figure 6.1 The Effect of Time on Bond PricesInterest Rate Changes and Bond PricesInterest Rate Changes and Bond Prices (continued)Textbook Example 6.7Textbook Example 6.7 (continued)Slide 556.3 The Yield Curve and Bond ArbitrageReplicating a Coupon BondReplicating a Coupon Bond (continued)Replicating a Coupon Bond (cont'd)Valuing a Coupon Bond Using Zero-Coupon YieldsCoupon Bond YieldsFinancial Calculator SolutionTextbook Example 6.8Textbook Example 6.8 (cont'd)Financial Calculator Solution6.4 Corporate BondsCorporate Bond YieldsCorporate Bond Yields (continued)Corporate Bond Yields (continued)Corporate Bond Yields (continued)Corporate Bond Yields (continued)Corporate Bond Yields (continued)Corporate Bond Yields (continued)Corporate Bond Yields (continued)Corporate Bond Yields (continued)Table 6.4 Bond RatingsTable 6.4 Bond Ratings (continued)Corporate Yield CurvesSlide 79Figure 6.4 Yield Spreads and the Financial Crisis6.5 Sovereign BondsSlide 82Figure 6.6 European Government Bond Yields, 1963–2011Chapter QuizChapter 6Valuing BondsCopyright ©2014 Pearson Education, Inc. All rights reserved.Chapter Outline6.1 Bond Cash Flows, Prices, and Yields6.2 Dynamic Behavior of Bond Prices6.3 The Yield Curve and Bond Arbitrage6.4 Corporate Bonds6.5 Sovereign BondsCopyright ©2014 Pearson Education, Inc. All rights reserved.Learning Objectives1. Identify the cash flows for both coupon bonds and zero-coupon bonds, and calculate the value for each type of bond.2. Calculate the yield to maturity for both coupon and zero-coupon bonds, and interpret its meaning for each.Copyright ©2014 Pearson Education, Inc. All rights reserved.Learning Objectives3. Given coupon rate and yield to maturity, determine whether a coupon bond will sell at a premium or a discount; describe the time path the bond’s price will follow as it approaches maturity, assuming prevailing interest rates remain the same over the life of the bond.Copyright ©2014 Pearson Education, Inc. All rights reserved.Learning Objectives4. Illustrate the change in bond price that will occur as a result of changes in interest rates; differentiate between the effect of such a change on long-term versus short-term bonds.5. Discuss the effect of coupon rate to the sensitivity of a bond price to changes in interest rates.6. Define duration, and discuss its use by finance practitioners.Copyright ©2014 Pearson Education, Inc. All rights reserved.Learning Objectives7. Calculate the price of a coupon bond using the Law of One Price and a series of zero-coupon bonds.8. Discuss the relation between a corporate bond’s expected return and the yield to maturity; define default risk and explain how these rates incorporate default risk.9. Assess the creditworthiness of a corporate bond using its bond rating; define default risk.Copyright ©2014 Pearson Education, Inc. All rights reserved.6.1 Bond Cash Flows, Prices, and Yields•Bond Terminology–Bond Certificate•States the terms of the bond–Maturity Date•Final repayment date–Term•The time remaining until the repayment date–Coupon•Promised interest paymentsCopyright ©2014 Pearson Education, Inc. All rights reserved.6.1 Bond Cash Flows, Prices, and Yields (continued)•Bond Terminology–Face Value•Notional amount used to compute the interest payments–Coupon Rate•Determines the amount of each coupon payment, expressed as an APR•the coupon rate is set by the issuer–Coupon PaymentCopyright ©2014 Pearson Education, Inc. All rights reserved.Zero-Coupon Bonds•Zero-Coupon Bond–Does not make coupon payments–Always sells at a discount (a price lower than face value), so they are also called pure discount bonds–Treasury Bills are U.S. government zero-coupon bonds with a maturity of up to one year.Copyright ©2014 Pearson Education, Inc. All rights reserved.Zero-Coupon Bonds (continued)•Suppose that a one-year, risk-free, zero-coupon bond with a $100,000 face value has an initial price of $96,618.36. The cash flows would be:–Although the bond pays no “interest,” your compensation is the difference between the initial price and the face value.Copyright ©2014 Pearson Education, Inc. All rights reserved.Zero-Coupon Bonds (cont'd)•Yield to Maturity = The discount rate that sets the present value of the promised bond payments equal to the current market price of the bond.•Price of a zero-coupon bondCopyright ©2014 Pearson Education, Inc. All rights reserved.Zero-Coupon Bonds (continued)•Yield to Maturity–For the one-year zero coupon bond:•Thus, the YTM is 3.5%.Copyright ©2014 Pearson Education, Inc. All rights reserved.Zero-Coupon Bonds (continued)•Yield to Maturity–Yield to Maturity of an n-Year Zero-Coupon BondCopyright ©2014 Pearson Education, Inc. All rights reserved.Textbook Example 6.1Copyright ©2014 Pearson Education, Inc. All rights reserved.Textbook Example 6.1 (continued)Copyright ©2014 Pearson Education, Inc. All rights reserved.Alternative Example 6.1•Problem–Suppose that the following zero-coupon bonds are selling at the prices shown below per $100 face value. Determine the corresponding yield to maturity for each bond. Maturity 1 year 2 years 3