Chapter 7
Interest Rates and Bond Valuation
Bond Features
Bond - evidence of debt issued by a corporation or a governmental body. A bond represents a loan made by investors to the issuer. In return for his/her money, the investor receives a legaI claim on future cash flows of the borrower. The issuer promises to:
Make regular coupon payments every period until the bond matures, and
Pay the face/par/maturity value of the bond when it matures.
Default - since the above mentioned promises are contractual obligations, an issuer who fails to keep them is subject to legal action on behalf of the lenders (bondholders).
Bond Value = Present Value of the Coupons
+ Present Value of the Face Value
Bond Value = INT [1 – (1/(1 + rd)N)]/rd + M * 1/(1 + rd)N
where: INT = the promised coupon payment
M = the promised face value
N = number of periods until the bond matures
rd = the market’s required return, YTM
If a bond has five years to maturity, an $80 annual coupon, and a $1000 face value, its cash flows would look like this:
Time 0 1 2 3 4 5
Coupons $80 $80 $80 $80 $80
Face Value $ 1000
Market Price $____
How much is this bond worth? It depends on the level of current market interest rates. If the going rate on bonds like this one is 10%, then this bond is worth $924.18.
5 N 10 I/Y 80 PMT 1000 FV CPT PV (-924.18)
Suppose a bond currently sells for $932.90. It pays an annual coupon of $70, and it matures in 10 years. It has a face value of $1000. What are its coupon rate, current yield, and yield to maturity (YTM)?
A.. The coupon rate (or just “coupon”) is the annual dollar coupon as