CHAP-5: BONDS

-Bond: T-Bond ; Corporate Bond; Municipal Bond; Foreign Bond.

-Sinking Fund: Provision to pay off a loan over its life rather all at maturity. Bond w/o sinkin fund always
rate below BBB (junk)
-Par value : Bond sold at $1000 . - If Rd < Coupon Rate: Bond sells at premium. When going rate>Coupon
Rate: Discount Bond
- Payment in Kind (PIK)Bond : don’t pay cash but coupons consisting of additional bonds. Company w/
cash flow problem. Risky
-Bond Valuation: A bond of 10 yr.,10%annuity of $100/yr.plus a lump sum at t=10:{n=10;I/yr.:10
;PMT:100;FV:1000;Ans.PV:(-1000)
-Coupon Rate : PMT/FV(normally $1000)
-Yield to Maturity(YTM): Rate of return earned on a bond held to maturity. YTM= Current Yield + Capital
Gains Yield.
- Current Yield : Annual Coupon Pmt. /Current price ; - Capital Gain Yield = Change in price/Beginning
Price.
-Semi Annual Bonds : N=2N ; I/YR = Rd /2 ; PV =Ok ; PMT = INT/2 ; FV=OK.
- YTC : N =when it can be called (say 5); PV :won’t change ; PMT: won’t change ; FV: change in question ;
I% =?
- YTC for semi-annual bonds : 2N ; PMT/2 ; whatever I% comes multiply that by 2 to get final interest
rate.
- Interest Rates go Up ; Bond prices fall. Expect YTC on premium bonds , YTC at par & discount bonds.
- (Rd = r* + IP + DRP + LP + MRP) ; Rd = Req. rate of return ; r*= Real risk free rate (0 inflation) ; IP =
Inflation Premium ;
DRP = Default Risk Premium ; LP = Liquidity Premium ; MRP = Maturity Risk Premium.
- Nominal Risk Free Rate (RRF) = r* + IP [Rate on Treasury Security] ;
- (TIPS) Treasury Inflation Protected Securities ; IP = Yield on Treasury Security – Yield on TIPS.
- Bond Spread [Corporate bond’s yield - T-Security yield of same maturity] = DRP+LP ; {Junk Bond
=greater spread , More risky}
- Yield(for US T-Bond) = Real Rate + IP + MRP as DRP = LP=0
- DRP for Corp. Bond =Corp. Bond Yield - T-Bond Yield – LP
- Interest Rate Risk : 1. Price & Interest rate are inversely related. 2. Longer term bond is riskier than
short term. 3. Lower coupon bond riskier than bonds with higher coupon.
-Zero coupon bonds. Don’t pay any coupon. PMT = 0
-Bankruptcy : Chap 11: Reorganization ; Chap -7 :Liquidation

CHAP-6:
-Investment Risk: the probability of earning a return less than expected.
- Expected Rate of Return (r) = ∑Pi ri , where Pi = Probability; ri = Rate of return.
- Standalone Risk : Measures the risk of a single asset. Std. Deviation (Sigma) = √ Variance = √ ∑ (ri –
r)2 Pi.
-Coefficient of Variation (CV) = Std. dev. / Expected Return.