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Bond Basics
Par Value: The par value is
the stated value of the
bond. The par value
generally represents the
amount of money the firm
borrows and promises to
repay on the maturity
date.
Issued 100 ,10% 5 years
bond of $1000.

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Bond Basics
Coupon Interest Bond:Company require to pay a fixed
number of dollars of interest each year.When this
coupon payment, as it is called, is divided by the par
value, the result is the coupon interest rate. For
example, Renker’s bonds have a $1000 par value, and
they pay $100 in $100 in interest each year. So its coupon
rate is $100 / 1000= 10%.

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Bond Basics
Coupon Payment: Will vary over a time, for these
floating bond rate, the coupon rate is set for, say the
initial six-month period, after which it is adjusted
every six months based on some market rate. Some
corporate issues tied to the Treasury bond rate, while
others issues are tied to other rates, such as LIBOR.
LIBOR(London Interbank Offered Rate )
 LIBOR or ICE is a benchmark rate that some of the world's leading banks
charge each other for short-term loans. It stands for Intercontinental
Exchange London Interbank Offered Rate and serves as the first step to
calculating interest rates on various loans throughout the world.

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Bond Basics
Floating rate: Many additional provision can be
included in floating-rate issues i.e some are issued to
convert at fixed –rate , where as others have upper
and lower limits(“caps” and “floors”) on how high and
low rate can go.
Which is popular for investors:
Floating rate is popular for investors who are worried
about the of rising interest rates, since the interest
paid on such bonds increases whenever market rates
rise.
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Bond Basics
Zero Coupon Bond: Some bonds pay no coupon at at
all, but are offered at a substantial discount below
their par values and hence provide capital
appreciation rather than interest income. In general
any bond offered originally at a price significantly
below its par value is called originally issued discount
(OID).
Payment in Kind(PIK): Some bonds don’t pay cash at
all but pay coupons consisting additional bonds.
These are called payment in kinds.
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Bond Basic
Maturity Date: Bonds generally have a specified
maturity date on which the par value must be repaid.
Redeem Bonds or Provisions to call: its generally
states that the company must pay the bondholders
can amount greater than the par value if they are
called. The additional amount is termed as Premium.
Premium

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Bond Basics
Bonds are simply long-term IOUs that represent
claims against a firm’s assets.
Bonds are a form of debt
Bonds are often referred to as fixed-income
investments.

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Bond Valuation
The value of any financial asset- a stock, a
bond,or even a physical asset such as apartment
building or a piece of a machinery – is simply the
present value of the cash flows the asset is
expected to produce.

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Key Features of a Bond
Maturity date – when the bond must be repaid.
Yield to maturity - rate of return earned on a bond
held until maturity.

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What is interest rate risk?
Interest rate risk is the concern that interest rates will
change, and therefore, a reduction in the value/price
of a security.

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Interest rate risk example
Suppose you just inherited $500,000. You intend to
invest the money and live off the interest.

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Interest rate risk example
You may invest in either a:
10-year bond
series of ten 1-year bonds
Both bonds currently yield 5%.

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If you choose the 1-year bond strategy:
After year 1, you receive $25,000 in
income and have $500,000 to reinvest.
But, if 1-year rates fall to 3%, your
annual income would fall to $15,000.

If you choose the 10-year bond strategy:

You can lock in a 5% interest rate, and
$25,000 annual income.

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 Interest Rate Risk
Price Risk
Change in price due to changes in
interest rates
Long-term bonds have more price risk
than short-term bonds
Low coupon rate bonds have more price
risk than high coupon rate bonds

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Bond Value
Bond Value = PV(coupons) + PV(par)
Bond Value = PV(annuity) + PV(lump sum)
Remember:
As interest rates increase present values decrease
( r → PV  )
As interest rates increase, bond prices decrease
and vice versa

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Inverse relationship of bond
price and rate
 For instance, if a zero-coupon bond is trading at $950 and has a par
value of $1,000 (paid at maturity in one year), the bond's rate of return
at the present time is approximately 5.26% ((1000-950) / 950 = 5.26%).

For a person to pay $950 for this bond, he or she must be happy with
receiving a 5.26% return. But his or her satisfaction with this return
depends on what else is happening in the bond market. Bond investors,
like all investors, typically try to get the best return possible. If current
interest rates were to rise, giving newly issued bonds a yield of 10%,
then the zero-coupon bond yielding 5.26% would not only be less
attractive, it wouldn't be in demand at all. Who wants a 5.26% yield
when they can get 10%? To attract demand, the price of the pre-
existing zero-coupon bond would have to decrease enough to match
the same return yielded by prevailing interest rates. In this instance,
the bond's price would drop from $950 (which gives a 5.26% yield) to
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$909 (which gives a 10% yield).
 Bond Valuation

Compute
Computethethevalue
valuefor
foran
anIBM
IBM Bond
Bondwith
withaa
6.375%
6.375% coupon
couponthat
that will
will mature
maturein
in55years
years
given
giventhat
thatyou
yourequire
requireanan8%
8%return
returnon
onyour
your
investment.
investment.

What
What are
arethe
theannual
annualinterest
interestpayments
payments($)?
($)?

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IBM Bond Timeline:

2009 2010 2011 2012 2013

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1,000.00

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 IBM Bond Timeline:

2009 2010 2011 2012 2013

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00

$63.75
$63.75Annuity
Annuityfor
for 55years
years $1000
$1000Lump
LumpSum
Sum in
in55years
years

VB=PMT(1-1/(1+r)n /r ) + M / (1+r)n

Interest paid each year

PMT=

M=the par or maturity value of bond

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 IBM Bond Timeline:

2009 2010 2011 2012 2013

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00

$63.75
$63.75Annuity
Annuityfor
for 55years
years $1000
$1000Lump
LumpSum
Sum in
in55years
years

= 63.75 PMT 1000 FV 8% I 5N

= PV = 935.12
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 Most Bonds Pay Interest Semi-Annually:

What is the value of a bond with a semi-annual

coupon with 5 years to maturity, 9% (nominal)
coupon rate if an investor desires a 10% (nominal)
return? Bond par value is $1000

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Most Bonds Pay Interest Semi-Annually:

e.g. semiannual coupon bond with 5 years

to maturity, 9% annual coupon rate.

Instead of 5 annual payments of $90, the bondholder

receives 10 semiannual payments of $45.

2013 2014 2015 2016 2017

0 1 2 3 4 5

45 45 45 45 45 45 45 45 45 45.00
1000.00

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Most Bonds Pay Interest Semi-Annually:

2013 2014 2015 2016 2017

0 1 2 3 4 5

45 45 45 45 45 45 45 45 45 45.00
1000.00
Compute
Computethethevalue
valueof ofthe
thebond
bondgiven
giventhat
thatyou
you
require
requireaa10%
10% s-a.
s-a. return
returnon
onyour
yourinvestment.
investment.
Since interest is received every 6 months, we need to use
semiannual compounding
VB =
45 - PMT
1000 - FV
5% - I 24
10 - N
Most Bonds Pay Interest Semi-Annually:

2013 2014 2015 2016 2017

0 1 2 3 4 5

45 45 45 45 45 45 45 45 45 45
1,000
Compute
Computethethevalue
valueof ofthe
thebond
bondgiven
giventhat
thatyou
you
require
requireaa10%
10% s-a.
s-a. return
returnon
onyour
yourinvestment.
investment.
Since interest is received every 6 months, we need to use
semiannual compounding

= PV = 1121.49
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Yield to Maturity (YTM)
Formula : YTM = (C+ F-P / n) / (F+P /2)
The price of a bond is $920 with a face value of $1000
which is the face value of many bonds. Assume that
the annual coupons are $100, which is a 10% coupon
rate, and that there are 10 years remaining until
maturity. This example using the approximate
formula would be YTM = (100 + 1000-920 /
10)/(1000+920/2)
=11.25%
C= Interest Payment , F=Face Value, P=Price, n=years
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 Difference between Coupon
and Yield to Maturity
One of the most important
things to understand is the
difference between coupon
and yield. Coupon tells you
what the bond paid when it
was issued, but the yield –
or “yield to maturity” – tells
you how much you will be
paid in the future

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Yield to Maturity
Suppose you were offered a 14 years, 10% annual
coupon , $1000 par value bond at a price $950.What
rate of interest would you earn on your investment if
you bought the bond and held at maturity.
10.62%

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Semiannual Bonds
Coupon rate = 14% - Semiannual
YTM = 16% (APR)
Maturity = 7 years
Value of bond?
Number of coupon payments? (2t or N)
14 = 2 x 7 years
Semiannual coupon payment? (C/2 or PMT)
$70 = (14% x Face Value)/2
Semiannual yield? (YTM/2 or I/Y)
8% = 16%/2

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Semiannual Bonds
 1 
Semiannual coupon = $70 1 -
Bond Value  C

 1
YTM
2
 2t 
 F

Semiannual yield = 8% 2

YTM
2 
 1  YTM 2  2t

 
Periods to maturity = 14  

Using the calculator:

Bond value = 14 N
70[1 – 1/(1.08)14] / .08 + 8 I/Y
1000 / (1.08)14 = 917.56 70 PMT
1000 FV
 1 
 1   CPT PV = -917.56
(1.08)14 1000
B  70   14
 0.08  (1 .08 )
 

Using Excel: =PV(0.08, 14, 70, 1000, 0)

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Yield to Maturity
2013 2014 2015 2016 2017
0 1 2 3 4 5

-1,000 80 80 80 80 80
1,000

 If bond Sells at a DISCOUNT (less than

$1,000) then YTM > Coupon Rate
 If bond Sells at a PREMIUM (more than
$1,000) then YTM < Coupon Rate

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 Valuing a Discount Bond
with Annual Coupons
Coupon rate = 10%
Annual coupons
Par = $1,000
Maturity = 5 years
YTM = 11%
Price= ?

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 Valuing a Discount Bond
with Annual Coupons
Coupon rate = 10% Using the calculator:
Annual coupons 5 N
11 I/Y
Par = $1,000 100 PMT
Maturity = 5 years 1000 FV
CPT PV = -963.04
YTM = 11%

Using the formula:  1 

 1  5 
B = PV(annuity) + PV(lump sum) B  100 (1 .11 ) 1000
 5
B = 369.59 + 593.45 = 963.04  0.11  (1 .11 )
 

Using Excel: =PV(0.11, 5, 100, 1000, 0)

Note: When YTM > Coupon rate  Price < Par = “Discount Bond”
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Valuing a Premium Bond
with Annual Coupons
Coupon rate = 10%
Annual coupons
Par = $1,000
Maturity = 20 years
YTM = 8%
Price = ?

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Valuing a Premium Bond
with Annual Coupons
Coupon rate = 10% Using the calculator:
20 N
Annual coupons
8 I/Y
Par = $1,000 100 PMT
Maturity = 20 years 1000 FV
CPT PV = -1196.36
YTM = 8%
Using the formula:  1 
1 
 (1.08) 20 
B = PV(annuity) + PV(lump sum) 1000
B  100 
B = 981.81 + 214.55 = 1196.36  0.08  (1.08)
20

 

Using Excel: =PV(0.08, 20, 100, 1000, 0)

Note: When YTM < Coupon rate  Price > Par = “Premium Bond”
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Yield to Maturity
If an investor purchases a 6.375% annual
coupon bond today for $900 and holds it until
maturity (5 years), what is the expected annual
rate of return (YTM)?
2013 2014 2015 2016 2017
0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

-900
1000.00
??
+ ??
900

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Yield to Maturity
• If an investor purchases a 6.375% annual coupon
bond today for $900 and holds it until maturity (5
years), what is the expected annual rate of return ?
Will it be >< than 6.375%?
2013 2014 2015 2016 2017
0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

-900
1000.00
??
+ ??
900 YTMB = 63.75 PMT 1000 FV
5N -900 PV
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I=?
 0 1 9 10
rd=?
...
90 90 90
PV1 1,000
.
.
.
PV10
PVM
887 Find rd that “works”!
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Government Bonds
Treasury Securities = Federal government debt
Treasury Bills (T-bills)
 Pure discount bonds
 Original maturity of one year or less

Treasury notes (T-notes)

 Coupon debt
 Original maturity between one and ten years

Treasury bonds (T-bonds)

 Coupon debt
 Original maturity greater than ten years

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Default risk
If an issuer defaults, investors receive less than
the promised return.
Influenced by the issuer’s financial strength
and the terms of the bond contract.

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Yield to Call
If you purchased a bond that was callable and the
company called it, you would not have the option of
holding the bond until it matured. Therefore the
Yield of maturity will not be earned.
Yield to call is a measure of the yield of a bond if you
were to hold it until the call date.

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Yield to Call
MicroDrive’s 10% coupon bonds were callable, and if
interest rates fell from 10% to 5% , then the company
could call in the 10% bonds, replace them with 5%,
bonds and save $100-50 = 50 interest per bond per
year. This would be beneficial to the company but not
for the bondholders.
Price of bond= (PMT/(1+r)n)+ (call Price / (1+r))

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Yield to Call
MicroDrive’s bonds had a provision that permitted
the company, if it desired, to call the bonds 10 years
after the issue date at a price of $1100.suppose further
that interest rate had fallen , and over year after
issuance the going interest rate had declined, causing
the price of the bond to rise to $1494.93.
Price of bond= (PMT/(1+r)n)+ (call Price / (1+r))

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Bond Value and YTM
1-Thatcher Corporation’s bonds will mature in 10 years.
The bond have aface value $1000 and an 8% coupon
rate, paid semi annually. the price of the bond $1100The
bond are callable in 5 years at a call price $1050.What is
the yield to maturity? What is the yield to call.
2-Renker Corporation bonds have 10 years maturity.
Interest is paid annually, the bonds have a $1000 par
value, and the coupon interest rate is 8% .The bonds
have yield to maturity of 9%.What is the current
market price of these bonds.

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Bond Value and YTM
Wilson Wonders bonds have 12 years remaining to
maturity. Interest is paid annually, the bonds have a
$1000 par value and the coupon interest rate is
10%.The bonds sell at a price of $850.What is their
YTM.

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