Bond Pricing and Yields

1
Chapter 13

• Bond Pricing and Yields

2
Bond prices and interest rates are inversely
related.

• 10 year bond with an 8 coupon
• Market interest rate Bond Price
• 12 774
• 11 823
• 10 877
• 09 936
• 08 1000
• 07 1070
• 06 1147
• 05 1232

3
Current yield

• CY Annual interest payment/Bond Market Price

4
Yield to maturityRequires holding the bond to
maturity to realize YTM

• Interest rate that discounts the future cash
  flows to the market price of the bond.
• Example 10 coupon, 3 years to maturity
• Market price907.20 YTM 14

5
Relationships

• CY YTM only if PB par
• Discount bonds YTM gt CY
• Premium bonds CYgt YTM
• Most bonds pay interest semiannually and have a
  face value of 1000.

6
Determinants of bond yields

• RKIPMRPDRPLRPTRPevent risk-covenants,
  where
• R is YTM or YTC
• K is the real rate of return in the economy
• IP is an inflation premium
• MRP is a maturity risk premium
• DRP is a default risk premium junk bonds
• LRP is a liquidity risk premium ability to sell
  the bond
• TRP is tax risk
• Event risk LBO, MA risk
• Covenants - if sinking fund, - if callable.
• Other