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									   Chapter 5 – Bonds and Bond
 Learning Objectives
   Apply the TVM Equations in bond pricing
   Understand the difference between annual
    bonds and semi-annual bonds
   Differentiate between different types of bonds
   Calculate yields on bonds Bond Features
   Understand basic features of bonds
   Delineate Bond Ratings
     Real vs. Financial Assets
 Real Assets have physical characteristics that
  determine the value of the asset
   Size, Shape, Material, Color, etc.
   Price based on the benefits of the physical
 Financial Assets physical characteristics are
   Value based on claim to promised or anticipated cash
   TVM concepts used to price financial assets
Application of TVM – Bond Pricing
 Bond instrument is a long-term debt
  instrument (long-term liability) of a
 Bond issuer promises a specific set of
  cash payments in the future
   Coupon (interest) payments
   Principal repayment
 Timing and amount of future cash
 payments stated on the bond…see Figure
 5.2 for time line of cash flow promises
Application of TVM – Bond Pricing
 Timeline for promised cash flows
     Example, Patel Corporation Bond
     $1,000 par value (principal)
     8% annual coupon payments (interest)
     Twenty year bond
 Principal $1,000 due 12/31/27 is lump sum
 Coupons of $80 annually are annuity
 What is the current value (present value)
 of these promised future cash payments?
 Application of TVM – Bond Pricing
 Steps to price a bond
   Determine annuity stream
      Coupon Rate times Par Value
      8% x $1,000 = $80
   Find PV of annuity stream
   Find PV of principal repayment
   Add PVs together for bond price
 Patel Corporation Bond
   PV of coupons is $917.59
   PV of principal is $311.80
   Price of Patel Corporation bond is $1,229.39
Application of TVM – Bond Pricing
   Key Components of a Bond
 Par Value or Face Value or Principal
 Coupon Rate (annual interest rate
 Coupon (regular interest payment)
 Maturity Date or Expiration Date (bond is
  totally repaid)
 Yield or Yield to Maturity or Discount Rate
           Semi-Annual Bonds
 Corporations and governments elect how often
  they will make coupon payments
    Most common choice is every six months
    Consistent with interest rates from chapter 4
       Coupon rate is stated annually
       Coupon payment = (Coupon Rate x Par Value) / 2
 Discount rate for TVM is the yield to maturity / 2
 Number of periods (n) is years x 2
 Timeline of promised cash flows, Figure 5.5
  page 117
Semi-Annual Bond
Three Methods to Bond Pricing
 Equations or Formula
   Solve the two pieces separately and add them
    up (coupons and principal present values)
 TVM Keys on a Calculator
   Note with TI BAII Plus…use of P/Y variable
   Compute price directly
 Spreadsheet
   Function is PV and variables require time
   Compute price directly
              Types of Bonds
 By Issuer
   Corporate Bonds – Companies
   Treasury Bonds – U.S. Government
   Municipal Bonds – State and Local
 By Features – Table 5.1, page 120
   Standard, Semi-Annual, Floating Rate
    (coupon rate changes), Zero, Consol,
   Callable, Putable, Convertible
  Pricing a Zero-Coupon Bond
 Special Pricing Feature of Zero-Coupon Bond
   No coupon payments
   Priced as Semi-Annual Bond for Principal repayment
 Also know as deep discount bond
   Price of bond is the initial principal
   Difference between price and final payment is interest
    on bond
 Interest is implied each year as bond price
  changes using the original yield to maturity
 Amortization schedule (Table 5.2) shows implied
  interest payments each six months
        Finding Yield to Maturity
 Yield to maturity – return on the bond if held to
   Discount rate for pricing the bond
   If price and cash flows are known you can find
   Iterative Process – can not isolate r in TVM
   Calculator or Spreadsheet fast and accurate
   Relationship of Coupon Rate and YTM (see
    Table 5.3)
              Bond Features
 Variables
    Price, Principal, YTM, Coupon Rate, Maturity
     Date, Frequency of Coupon Payments
    Need all but one variable to determine
     missing variable
 Indenture or Deed of Trust (Bond Contract)
 Collateral or Security of Bond
   Real Property is Collateral – Mortgage Bond
   No Collateral - Debenture
             Bond Features
 Senior Debt versus Junior Debt
   Older Issue is Senior
   Junior Debt paid off after Senior Debt
 Protective Covenants
   Prohibits actions of bond issuer
   Designed to protect bondholder
 Added Features to Bond (Options)
   Call, Put, Conversion
   Provides issuer or holder future choices
             Bond Ratings
 Agencies Rate Bonds
   Ratings based on potential default
   Best rating AAA
 Categories based on ratings (Table 5.4)
   Investment Grade (AAA to BBB- or Baa3)
   Speculative Grade (BB+ or Ba1 to B- or B3)
      Also known as Junk Bonds
   Extremely Speculative (C rating group)
   Default (D rating by Standard and Poor’s)
 Quoting Conventions and Markets
 Bonds usually trade in a dealer market
   Dealers state buying and selling prices
   Dealers usually in money center banks
 Some bonds listed on NYSE
   Bonds listed by issuing company
   Bond’s coupon rate and maturity date part of
    the bond name
   Current yield
   Volume, Closing Price, and Net Change

 Problem 2 – Pricing with Semi-Annual
   Problem 6 – Yield on Semi-Annual Bonds
   Problem 10 – Coupon Rates
   Problem 12– Pricing Semi-Annual Bond
   Problem 14 – Zero Coupon Bond
Appendix – Government Bonds
 Names of federal government bonds
 based on maturity dates at issue:
   U.S. Treasury Bill, maturity less than one year
   U.S. Treasury Note, maturity between two
    and ten years
   U.S. Treasury Bonds, maturity over ten years
 Pricing for Notes and Bonds…
   Semi-annual coupon bonds
   Another application of TVM equations
         U.S. Treasury Bills
 Treasury Bills are short term pure discount
  bills (pay no interest)
 Pricing formula discounts but ignores
  compounding and conventional return
  calculation methods
 Formula:

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