Bonds - Business Administration - Lecture Notes, Study notes of Business Administration

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Financial Analysis

Bonds

1. Bond Terminology

a) Bond Certificate

b) Maturity Date

c) Term

d) Coupon

e) Par or Face Value

f) Coupon Rate

g) Coupon Payment

2. Zero Coupon Bonds

a) Structure of zero coupon bonds

b) Example: Suppose that the following zero-coupon bonds are selling at the prices shown below per $100 face value: Maturity Price 1 years $98. 2 years $95. 3 years $91. 4 years $87. c) Determine the corresponding yield to maturity for each bond.

4. Premium vs. Discount Bonds

a) Notice that in the example above, the bond’s price was $1,080.55 when its yield to maturity was 7.5 percent.

• This is an example of a “premium” bond.

b) When the YTM = 10%, the bond was a discount bond, priced below par value.

c) There is an inverse relationship between market interest rates and bond prices.

5. Dynamic Behavior of Bond Prices

a) Premium Bonds

• In the example above, what will be the price of the premium bond in 1 year if the yield to maturity (required return) remains unchanged?

b) Discount Bonds

• What is the price of the discount bond in 1 year if the yield to maturity remains unchanged at 10%?

c) Sensitivity of bond prices to interest rate changes

• The degree to which the bond’s price is affected by changes in interest rates depends on the bond’s duration. − The longer before the bond matures, the more a given change in market interest rates affects the price of a bond.

d) The Effect of Time on Bond Prices

• Bond price movements over time reflect both the required yield on the bonds and the passing of time as the bond approaches maturity:

• Because coupon payments are received at fixed points in time, actual bond prices follow a sawtooth pattern over time.

6. Bond Ratings