Bonds Beginning Lesson
Introduction
Bonds are fixed income securities that promise to pay an agreed amount at the time of maturity
called the par value as well as periodic payments called coupon payments. The current price of
the bond is determined by using current market interest rates to discount (refer to TVM lesson)
all future cash inflows. It is how much you should be willing to pay for the bond today. Bonds are
safer investments than stocks because not only do pay have guaranteed cash flows, but if the
issuer declares bankruptcy bondholders get first dibs on auctioning off assets.
See more detailed bond calculator on the next worksheet
Important Terms
Par Value: Amount that will be due at the end of the the bond. Also known as the "face value".
Maturity: Date that the remaining debt (Par Value) becomes due.
Interest Rate: The rate that market conditions demand for a similar investment (risk and maturity).
Coupon Rate: Percentage of par value that establishes what the coupon payments will be.
Coupon Payment: Payments to the bond-holder that are either yearly, semi-annually, or monthly.
Price: Present value of par value and all coupon payments discounted at the interest rate.
There are 3 types of bonds Bonds are named comparing their market values to their par values.
1. Par Value Bond: Its market value is the same as its par value. This occurs when the coupon rate and interest r
Par
Example: Value $1,000 Year Bond Price $1,200
Maturity 5 0 $1,000.00
$1,000
Interest Rate 9% 1 $1,000.00
Coupon Rate 9% 2 $1,000.00
3 $1,000.00
Bond Price $1,000 4 $1,000.00
5 $1,000.00
2. Premium Bond: Its market value is greater than its par value. The coupon rate is greater than the market inte
Since the bond's coupon payments are greater than the average market rate, investors are wi
Par
Example: Value $1,000 Year Bond Price
Maturity 5 0 $1,079.85
Interest Rate 8% 1 $1,066.24
Coupon Rate 10% 2 $1,051.54
3 $1,035.67
Bond Price $1,080 4 $1,018.52
5 $1,000.00
3. Discount Bond: It's market value is less than its par value. The coupon rate is less than the market interest ra
Since the bond's coupon payments are less than the average market rate, investors are only w
Par
Example: Value $1,000 Year Bond Price
Maturity 5 0 $924.18
Interest Rate 10% 1 $936.60
Coupon Rate 8% 2 $950.26
3 $965.29
Bond Price $924 4 $981.82
5 $1,000.00
Bonds can also be classified by issuer.
Treasury Bonds Municiple Bonds
• Issued by national governments • Issued by states, counties, or cities
• Finances national operations • Finances specific projects such as a
not paid for by taxes. new bridge or general operations
not paid for by local taxes.
Market interest rates according to credit rating and maturity: (US treasuries are considered "risk free" so they all hav
US Treasury Bonds Municipal Bonds
Maturity Yield Yesterday Last Week Last Month Maturity Yield Yesterday
3 Month 0.07 0.05 0.01 0 2yr AA 0.67 0.6
6 Month 0.14 0.11 0.06 0.09 2yr AAA 0.38 0.45
2 Year 0.35 0.41 0.38 0.46 2yr A 1.05 0.98
3 Year 0.53 0.66 0.66 0.76 5yr AAA 1.29 1.3
5 Year 1.35 1.52 1.51 1.69 5yr AA 1.53 1.52
10 Year 2.8 2.94 2.96 3.11 5yr A 1.82 1.82
30 Year 4.12 4.25 4.26 4.38 10yr AAA 2.63 2.63
10yr AA 2.94 2.91
10yr A 3.09 2.93
20yr AAA 3.98 3.87
20yr AA 5.6 5.67
20yr A 5.18 5.37
As you can see, treasuries have the lowest rates (are the least likely to default) and corporates have the highest rates (high
Bond prices and
market interest rates
Relationship between interest rates and bond prices move in opposite
directions.
Bond Interest
Interest Bond
Price Calculator
e "face value". Par Value $1,000
Maturity (Yrs) 20 Tip:
and maturity). Interest Rate 9.00% Do NOT mix up the coupon and market rates.
Coupon Rate 8.00%
Bond Price $908.71
interest rate.
Input
upon rate and interest rate of a bond are equal.
Bond Price Change Approaching Maturity
$1,200
$1,000
$800
$600
$400
$200
$0
1 2 3 4 5 6
er than the market interest rates.
et rate, investors are willing to pay extra for the bond.
Bond Price Change Approaching Maturity
$1,100
$1,080
$1,060
$1,040
$1,020
$1,000
$980
$960
$960
1 2 3 4 5 6
n the market interest rates.
ate, investors are only willing to buy the bond at a discount.
Bond Price Change Approaching Maturity
$1,020
$1,000
$980
$960
$940
$920
$900
$880
1 2 3 4 5 6
Corporate Bonds
• Issued by corporations
• Finances company operations
or new projects that are not
paid for by equity (stocks).
isk free" so they all have the same credit rating)
Corporate Bonds
Last Week Last Month Maturity Yield Yesterday Last Week Last Month
0.59 0.67 2yr AA 0.92 0.97 0.99 0.99
0.38 0.49 2yr A 1.11 1.16 1.22 1.25
0.96 1.11 5yr AAA 1.65 1.81 1.83 1.9
1.23 1.23 5yr AA 2.44 2.62 2.68 2.64
1.53 1.52 5yr A 2.66 2.91 2.87 2.82
1.87 2.15 10yr AAA 2.92 3.08 3.14 3.34
2.62 2.67 10yr AA 3.89 4.03 3.98 4.24
2.95 3.01 10yr A 3.94 4.1 3.87 4.15
3.18 3.37 20yr AAA 4.91 5.11 5.09 4.99
4.01 4.09 20yr AA 5.14 5.14 5.44 5.33
5.68 5.4 20yr A 5.07 5.27 5.26 5.16
5.14 5.19
e the highest rates (highest default risk). Municiples are in between.
prices and
et interest rates
in opposite
$1,000
$1,000
$1,000
$1,000
$1,000
$1,000
$1,080
$1,066
$1,052
$1,036
$1,019
$1,000
$924
$937
$950
$965
$982
$1,000
Bond Price Calculator
Bond Price Calculation:
Step 1. In Cell E12 choose annual, semi-annual, or monthly coupon payments below.
Step 2. Choose par value (usually $1,000 or $10,000), bond length, interest rate, and coupon rate. Coupon payme
In the calculator box we see Excel functions in use and the concept is illustrated in the cells to the right.
6 Month
Periods
Calculator 1
Number of Payments/Yr: 2 2
Par Value: $1,000.00 3
Years Until Maturity: 10 4
Market Interest Rate: 10.00% 5
Coupon Rate: 8.00% 6
Coupon Payment: $40.00 7
Bond Type: Discount Bond 8
Bond Price: $875.38 9
10
11
12
Tip: Maturity, Interest and coupon rates must take 13
into consideration the number of payments per year. 14
The Excel function also results in a negative number so 15
a negative sign is placed at the beginning. The two 16
negatives make it positive.
17
18
19
20
upon rate. Coupon payment, bond price, and bond type will automatically calculate.
ells to the right.
Coupon Discounted
Payment Payment Bond Price
$40.00 $38.10 $875.38
$40.00 $36.28
$40.00 $34.55
$40.00 $32.91 Tip: Because of the Time Value of Money, it is
$40.00 $31.34 apparent that sooner payments are more valuable
$40.00 $29.85 than later ones. This effect will increase if the
$40.00 $28.43 market interest rate goes up and will decrease if it
$40.00 $27.07
$40.00 $25.78
$40.00 $24.56
$40.00 $23.39
$40.00 $22.27
$40.00 $21.21
$40.00 $20.20
$40.00 $19.24
$40.00 $18.32
$40.00 $17.45
$40.00 $16.62
$40.00 $15.83
$1,040.00 $391.97