Chapter 7 Bond Valuation

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• Chapter 7Bond Valuation

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KEY CHARACTERISTICS OF BONDS

• The face value of most corporate and government
  bonds is _____.
• The _____ is multiplied by the face value to
  determine the size of the annual interest
  payments.
• American-style bonds make coupon payments _____,
  while European-style bonds make coupon payments
  _____.

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• The number of years that a bond will make
  interest payments is called the bonds _____.
• The rate of return the bond investor expects to
  receive on the bond (rd) is called its _____.
• The market price of a bond is determined by _____.

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COMPUTING BOND VALUE

• A bonds price (i.e., value) is equal to the
  present value of its _____.
• What are the cash benefits of a 10-year 1,000
  (par value) bond paying a 6 annual coupon
  rate?
• What is the bonds value if your yield to
  maturity (rd) is 7?

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• What happens to the bond price if market yields
  (rd) immediate rise to 9?
• The relationship between the bonds market price
  and its yield to maturity is _____.

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• This bond is now selling at a _____.
• With a discount bond, the yield is _____ than the
  coupon rate.
• With a premium bond, the yield is _____ than the
  coupon rate.

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• What would be the bonds price if the yield (rd)
  is 4?

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Changes in Bond Values Over Time

• What happens to the 10-year bonds value next
  year? (Assume bond yields remain at 7)
• As a discount bond approaches maturity, its
  market price will _____. As a premium bond
  approaches maturity, its market price will _____.

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COMPUTING BOND YIELD

• If you can buy the bond for 950, what is your
  yield (rd)? (Assume a 10-year bond)
• Finding bond yield is a _____ process. (Did you
  calculator pause?)

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COMPUTING YIELD TO CALL

• If the issuing company can force you to sell the
  bond back to them at a pre-determined price, the
  bond is said to be _____.
• The price the company pays you for the bond is
  called the _____ price.

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• What is your yield-to-call on the bond if its
  current price is 950 and it is called at 1,040
  after 4 years?
• Because the yield-to-call (8.4) is greater than
  the yield-to-maturity (6.7), we would expect the
  company to _____ the bonds.

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COMPUTING CURRENT YIELD

• What is the bonds current yield? (Assume a 950
  price)

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• The current yield _____ consider capital gains or
  losses.
• For a discount bond, the current yield will be
  _____ than the yield to maturity.
• For a premium bond, the current yield will be
  _____ than the yield to maturity.

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COMPUTING BOND PRICE WITH SEMIANNUAL COUPONS

• To compute the price for an American-style bond,
  we must work with _____ time periods.
• What is the price of an American-style bond with
  a 10-year maturity, a 6 coupon rate, and a yield
  (rd) of 7?

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• What is the yield of this American-style bond if
  it costs 950?
• The investor would expect a return of 6.694
  compounded _____.
• The effective yield would be _____ than the
  nominal yield of 6.694.

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COMPUTING EFFECTIVE YIELD FOR AN AMERICAN-STYLE
BOND

• We just computed a nominal yield for our bond.
  How would be its effective yield?
• Just like a bank account that pays 6.694
  compounded semiannually, we would expect our true
  (annually compounded equivalent) return to be
  _____ (specifically, _____).

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• With an American-style bond, the effective yield
  is _____ the nominal yield (because the bond
  provides _____ compounding).
• With a European-style bond, the effective yield
  is _____ the nominal yield (because the bond
  provides _____ compounding).

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INTEREST RATE RISK

• Assuming a 6 coupon rate and annual coupon
  payments
• Yield 10-year 1-year
• 7 929.76
• 4 1162.22
• ?232
• What would be the bonds two prices if it were a
  one-year bond?

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• Which bond would have the greater price drop if
  yields immediately rose from 4 to 7?
  _____
• Interest-rate risk refers to the risk that
  interest rates will _____ causing bond values to
  _____.
• Interest-rate risk is greater with the _____-term
  bond.

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• Suppose you invest your life savings in 30-year
  T-bonds (8 semiannual coupons) when market
  yields are 5. What is the price of each bond?
• What happens to the price if yields quickly rise
  to 9?

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REINVESTMENT RATE RISK

• Consider two bonds with 10 (annual pay) coupon
  rates. One bond is a 10-year bond, the other is
  a 1-year bond.
• How much cash will you receive to reinvest next
  year with the 10-year bond? _____
• How much cash will you receive to reinvest with
  the 1-year bond? _____

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• With which bond would you be more concerned about
  interest-rates falling next year? _____
• Reinvestment-rate risk is the risk that yields
  will _____ causing cash proceeds to be reinvested
  to earn a _____ rate of return. This risk is
  greater with _____-term bonds.

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Bond Ratings

• Default risk is the risk that the company will go
  _____ and be unable to make interest or principal
  payments on bonds.
• Bond ratings are a measure of _____ risk.
  
• Other things held constant, the better (i.e.,
  higher) a bonds rating, the _____ will be its
  yield.

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BOND LISTINGS

• Cur
• Bond Yld Vol Close NetChg
• BellsoT 6¼13 6.1 25 102.63 -0.16
• The above bond has a _____ coupon rate, and
  matures in the year _____.
• Its price would be _____.
• Yesterdays price was _____.

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BOND SPECULATION

• If you expect market yields to drop next year,
  you should _____ long-term bonds.

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• What is your one-year return if you buy a 10-year
  bond with a 10 coupon rate (annual pay) now
  while yields are 12, and sell it a year later
  when yields have dropped to 7?

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ZERO BOND

• A zero is a bond with a zero _____
  rate.
• What is the price of a 30-year, American-style
  zero if its yield is 8?

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• What is the price of this bond a year later if
  yields are unchanged?
• If you are in a 30 tax bracket and dont sell
  the bond, what would you owe in taxes?

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Terms

• Consider the three types of bonds below
• U.S. Treasury Corporate Municipal
• With which bond would you
• not have to pay any state income tax? _____
• not have to pay any state or federal income
  tax? _____
• have to pay both state and federal income tax?
  _____

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• Consider types of international bonds Foreign
  bonds Euro Bonds
• Which type of bond is denominated in and
  registered with the SEC? _____
• Which type of bond is denominated in a foreign
  currency and not registered with the SEC?
  _____
• Which bond has more exchange rate risk? _____

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• Consider two types of bonds Mortgage bond
  Debenture bond
• Which type of bond is backed by collateral in the
  form of real estate and buildings? _____
• Which type of bond has no collateral backing?
  _____
• Other factors held constant, which should offer
  the higher yield? _____

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• Consider two types of bonds
• Debenture Subordinated deb.
• Which type of bond would be paid first in the
  event of bankruptcy? _____
• Other things held constant, which type of bond
  should offer the higher yield? _____

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• Consider two bond features
• Callable Sinking Fund
• Which feature requires the company to make
  payments into a fund to ensure there are
  sufficient funds to pay the bondholders at
  maturity? _____
• Other things held constant, which type of bond
  should offer the higher market yield? _____

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• Consider two types of bonds
• Convertible Floating rate
• Which type of bond offers the investor unlimited
  upside potential? _____
• Which type of bond protects the investor from
  interest-rate risk? _____

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• What is the term for the bond contract? _____
• What is the term for the clauses in the bond
  contract that restrict the companys activities?
  _____
• Who is responsible for monitoring the companys
  activity to ensure that it abides by the
  contract? _____