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Understanding Bond Valuation and Pricing Principles

Learn how to value bonds using present value formulas, examine pure discount bonds, understand coupon bonds and yield-to-maturity, analyze bond listings, explore the relationship between yields and maturity, and observe bond price behavior over time. Discover the principles of bond pricing, including trading at par value and calculating yield-to-maturity for coupon bonds.

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Understanding Bond Valuation and Pricing Principles

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Presentation Transcript

  1. Chapter 8 Contents • 1 Using Present Value Formulas to Value Known Flows • 2 The Basic Building Blocks: Pure Discount Bonds • 3 Coupon Bonds, Current Yield, and Yield-to-Maturity • 4 Reading Bond Listings • 5 Why Yields for the same Maturity Differ • 6 The Behavior of Bond Prices Over Time

  2. Bond Prices Rise as the Interest Rates Fall • Write the PV of the fixed income security as the sum terms

  3. Pure Discount Bonds • The pure discount bond is an example of the present value of a lump sum equation we analyzed in Chapter 4 • Solving this, the yield-to-maturity on a pure discount bond is given by the relationship:

  4. Pure Discount Bonds • In this equation, • P is the present value or price of the bond • F is the face or future value • n is the investment period • i is the yield-to-maturity

  5. Pure Discount Bonds

  6. Bonds Trading at Par • Bond Pricing Principle #1: (Par Bonds) • If a bond’s price equals its face value, then its yield-to-maturity = current yield = coupon rate. Proof:

  7. First Solution Method

  8. Second Solution Method

  9. The YTM of the Coupon Bond

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