Chapter 10 Bond Prices and Yield a security that obligates the issuer to make specified payments to the I Bond Characteristics a Bond holder at the maturity of the bond provides only a payment of par value at maturity issued 1 10 years issued 10 30 years b ParValue c Coupon Rate d Zero Coupon Bond the repayment to the bondholder at the maturity of the bond the bonds annual interest payment per dollar of par value a bond paying no coupons that sells at a discount and e Treasury Notes f Treasury Bonds g Accured Interest Annual Coupon Payment 2 Days since last Coupon Payument Days separating Coupon Payments h Corporate Bonds i If someone buys a bond and it is between coupon days then the person is owed some accured interest on the coupon of the bond ii This is why bonds are priced at par value right before they mature even though the person who buys bond would get coupon payment This money would go to person who owned the bond the longest i Market is quite thin and is low turnover ii Callable Bonds specified call price during the call period bonds that may be repurchased by the issuer at a 1 If bonds are issued at a high coupon rate because that is what the market rate is and interest rates drop then the company can aviond paying the high interst rate and call the bonds 2 Usually issued at a rate above the interst rate to attract investors since they know the bond is callable iii Convertible Bonds A bond with an option allowing the bondholder to exchange the bond for a specified number of shares of common stock in the firm 1 Are usually issued at lower coupon rates because if the stock appreciates the bond holders can convert to stock and make profit iv Put Bond A bond that the holder may choose either to exchange for par value at some date or to extend for a given number of years If coupon rate exceeds the current market yield the bondholder twill choose to extend the bonds life 1 v Floating Rate Bond according to a specified market rate Bonds with coupon rates periodically reset i Preferred Stock i Although equity it promises to pay a specified stream of dividends ii If they do not pay dividends it is not bankrupt it simply accumulates amount iii Mostly held by corporations due to tax advantages in receiving it in corporate tax rates It is not tax deductable for the companies Paying the tax rate to pay iv j Foreign Bonds issued by a borrower for a country other than the one in which the bond is sold The bond is denoted in the currency in which it is sold i Yankee Bonds foreing bonds sold in USA regulated by SEC 1 issued in the currency of one country but sold in other national k Eurobonds markets i Not regulated by SEC Innovation of the Bonds Market l i Inverse Floaters interst rate falls on these bonds when the general interst rate rises ii Asset Backed Bonds backed by assets 1 Mortgage Backed Securities 2 Bowie Bonds tied to record sales of David Bowie 3 Disney offers bonds tired to movies iii Pay In Kind Bonds may pay cash in interst or additional bonds iv Catastrophy Bonds investors take on risk of insurance company if disaster strikes investor loose investment 1 v Indexed Bonds 1 TIPS II Bond Pricing a Bond Pricing PV of Coupons PV of Par Value b Bond Value Coupon 1 r t Par Value 1 r t c Invoice Price Flat Price Accured Interest III Bond Yields a Yield To Maturity bonds payment equal to its price the discount rate that makes the present value of a i Average rate of return one can earn on the bond if it is held now to 1 10 year bond with semiannual payemts would be n 20 maturity b Calculator Calculations i n number of time periods i interest rate per period as a ii iii PV present Value iv Future Value v PMT recurring payments 1 Coupon Bonds PMT is the coupon payment 2 0 Coupon PMT 0 Annual coupon divided by bond price bonds selling above par value Bond selling below par value c Current Yield d Premium Bond e Discount Bond f Yield To Call i Issue can call bond if the present value is greater than the call price at the expense of the bondholder ii The price of a callable bond and straight bond begin to diverge as bond prices fall and flattens out at call price iii Calculated same way except call price replaces par value and yield IV Bond Prices Over Time to call yield to maturity a Yield to Maturity Versus Holding Period Return i Yield to Maturity Depends on Bond Coupon Current Price Par 1 Average rate of return if held to maturity ii Holding Period Return Rate of return over a particular investment Value at Maturity period V Yield Curve 1 depends on value that is not know today a graph of yield to maturity as a function of term to maturity a Expectations Theory solely by expectations of future short term interest rates the theory that yields to marturity are determined b Liquidity Preference Theory investors demand a risk premium on long i Liquidity Premium investors as compensation for the greater risk of longer term bonds the extra expected return demanded by i See Figure 10 13 term bonds ii Pg 320 Summary iii