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Understanding Bond Valuation and Pricing: Key Terms and Calculations

This guide provides an overview of essential bond valuation concepts, including key terms like principal, coupon, yield, and yield to maturity. It explores various bond types such as municipal, government, and corporate bonds, along with pricing details such as discount, premium, and par. The text includes a practical bond valuation problem to calculate the price of a corporate bond based on given yields, and explains the significance of accrued interest when bonds are traded between investors. A financial calculator example highlights these concepts in action.

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Understanding Bond Valuation and Pricing: Key Terms and Calculations

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  1. Bond Valuation John Comiskey Fred Knecht

  2. Terms • Principal – Amount of the loan on which the interest is calculated. Also called face value • Coupon – Rate of interest • Yield – Internal rate of return • Yield to Maturity – Internal rate of return over the life of a bond

  3. Types of Bonds • Municipal Bonds – State bonds • Government Bonds – Federal bonds • Corporate Bonds – Corporate debt

  4. Pricing Bonds • Discount – Bond selling at less than face value • Premium – Bond selling over face value • Par – Selling precisely for face value

  5. Price-Yield Relationship Price = NPV (Coupons) + NPV (Principal)

  6. Bond Problem • Calculate the price of a 6% August 15, 2009 bond if when issued on August 15, 2005, the prevailing yield was 7%. Face value is $1,000.

  7. Financial Calculator • Calculate the price of a 6% August 15th, 2009 corporate bond if, when it was issued August 15th, 2005, the prevailing yield was 7%. Face value is $1,000. • Use the bond spreadsheet • 2nd, 9

  8. Calculate the price of a 6% August 15th, 2009 corporate bond if, when it was issued August 15th, 2005, the prevailing yield was 7%. Face value is $1,000. = $965.63 SDT – 8.1505 CPN – 6 RDT – 8.1509 RV – 100 360 2/Y YLD – 7 PRI – CPT = 96.563 Financial Calculator

  9. Accrued Interest 8/15/2005 8/15/2006 8/15/2007 8/15/2008 8/15/2009 • At what price does this bond trade at if it were sold for settlement May 17th, 2006 to a new investor? 2/15/2006 2/15/2007 2/15/2008 2/15/2009 $30 $30 $30 $30 $30 $30 $30 $1030 5/17/2006

  10. Accrued Interest 2/15/2007 5/17/2007 8/15/2007 • Since the coupon on August 15th, 2007 will be paid to the new owner, the original owner’s share of the coupon must be accounted for. 88 days 92 days $30 $30 Corporate Bond semi-annual period = 180 days

  11. Accrued Interest • 92/180 * $30 = Accrued Interest = $15.33 • This is how much of the coupon the original investor deserves for owning the bond 92 days out of the 180 day period. • The price of the bond includes this accrued interest, so that when the bond is sold, the original owner gets his portion of the coupon.

  12. Accrued Interest $1030/1.035^(4+88/180) + $30/1.035^(3+88/180) + $30/1.035^(2+88/180) + = $994.76 = Invoice Price $30/1.035^(1+88/180) + $30/1.035^(88/180) 5/17/2007 8/15/2007 8/15/2008 8/15/2009 2/15/2008 2/15/2009 88 days 180 days 180 days $30 $30 $30 $30 $1030 Time = 88/180 period Time =1 88/180 period Time = 2 88/180 period Time = 3 88/180 period Time = 4 88/180 period

  13. If using the calculator, the price calculated is the base price, which you would have to add the accrued interest to in order to get the invoice price. $979.43 + $15.33 = $994.76 Accrued Interest • SDT – 5.1707 • CPN – 6 • RDT – 8.1509 • RV – 100 • 360 • 2/Y • YLD – 7 • PRI – CPT = 97.943 • AI – 1.533

  14. Questions? Bond Valuation John Comiskey Fred Knecht

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