Bond Prices and Yields

Ranjeeta Sadhwani Warsha Devi Erum Akhtar Hina Chimnani Beena Zaidi

Group Members:

Outline
Bond Characteristics Bond Pricing Bond Yields Bond Prices Over Time Default risk and Bond Pricing

Bond Characteristics
Presenter: Ranjeeta Sadhwani

Bond Prices and Yields Bond: Bond Typically a bond issuer makes semi-annual coupon Characteristics payments and pays the bonds par value at maturity. Face or par value

Coupon rate Zero coupon bond

Indenture: loan contract between the bond issuer and bondholder.

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Accrued interest invoice price = flat (stated, quoted) price + accrued interest Example: 10% coupon. 90 days have passed since the last coupon payment. There are 182 days between two coupon payment dates. Accrued interest=$100*(90/365)=$24.66, or

=$50*(90/182) = $24.73

Issuers of Bonds
Treasury Notes and Bonds Corporate bonds Call provision on Corporate bonds Convertible bonds Puttable bond

Floating rate bond

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International bonds
Foreign bonds and Eurobonds

Innovation in the Bond Market

Inverse Floaters Asset-Backed Bonds Catastrophe Bonds Indexed Bonds
RRB (Real Return Bonds) TIPS (Treasury Inflation Protected Security)

Table 14.1 Principal and Interest Payments for a Treasury Inflation Protected Security

Bond Pricing
Presenter: Warsha Devi

Bond Prices and Yields

Ct F P T t t 1 (1 r ) (1 r )
Bond Pricing
P = price of the bond Ct = interest or coupon payments F = face value T = number of periods to maturity r = the appropriate discount rate for a period

Example: bond price

30-yr, 8% semiannual coupon Bond, F = $1,000, with ytm=10% p.a. Ct = 40 (semiannual payment) P = 1000 T = 60 periods r = 5% (semiannual rate)

1 1,000 P 40 t (1 0.05) (1 0.05)60 t 1

P = $810.71

60

Bond Prices and Interest Rates

Prices and yields (required rates of return) have an inverse relation When yields get high the value of the bond will be low The longer the maturity is, the bond price is more sensitive to changes in interest rates. To a large extent, treasury bill is default free and interest rate risk free.

The Inverse Relationship Between Bond Prices and Yields

Bond Yields
Presenter: Erum Akhtar

Bond Prices and Yields

Interest rate that makes the present value of the bonds payments equal to its price. It is the solution r:

P Ct t t 1 (1 r )
T

F T (1 r )

Bond Yields

Example: 10 year, 7% coupon bond, P=$950. Solve for r = semiannual rate:

950=t=1,20 35/(1+r)t + 1000/(1+r)20 r=3.8635% for 6 months

Yield Measures
Bond Equivalent Yield 7.72% = 3.86% x 2 Effective Annual Yield (1.0386)2 - 1 = 7.88% Current Yield Annual Interest / Market Price $70 / $950 = 7.37 % Yield to Call

Yield to Call

Realized Yield versus YTM

Reinvestment Assumptions Holding Period Return Changes in rates affect returns Reinvestment of coupon payments Change in price of the bond

Growth of Invested Funds

Bond Prices Over Time

Presenter: Hina Chimnani

Bond Prices and Yields

Coupon rate = Market interest rate Coupon rate > Market interest rate Coupon rate < Market interest rate
Bond Prices Over Time

Prices over Time of 30-Year Maturity, 6.5% Coupon Bonds

YIELD TO MATURITY versus HOLDING PERIOD RETURN

Holding-Period Return: Single Period

HPR = [ I + ( P0 - P1 )] / P0 where I = interest payment P1 = price in one period P0 = purchase price

Holding-Period Return Example

CR = 8% YTM = 8% N=10 years Semiannual Compounding P0 = $1000 In six months the rate falls to 7% P1 = $1068.55 HPR = [40 + ( 1068.55 - 1000)] / 1000 HPR = 10.85% (semiannual)

Zero Coupon Bonds and Treasury Strips

Original-Issue Discount Bonds Zero-coupon Bonds Short-term zero coupon bonds Long-term zero coupon bonds STRIPS and Treasury strips

The Price of a 30-Year Zero-Coupon Bond over Time at a Yield to Maturity of 10%

Default Risk And Credit Rating

Presenter: Beena Zaidi

Bond Prices and Yields

Rating companies
Moodys Investor Service Standard & Poors Fitch

Rating Categories
Investment grade Speculative grade/Junk Bonds Default Risk and Ratings

Factors used by rating companies

Coverage ratios TIE Leverage ratios Liquidity ratios Current ratio Quick ratio Profitability ratios ROA ROE Cash flow to debt

Protection against default

Indenture: Sinking funds Subordination of future debt (me-first rule) Dividend restrictions Collateral Ytm and default risk Expected yield vs promised yield on corporate bonds would be different due to default risk. Promised yield is the maximum possible yield.

Default Risk and Yield

Default premiums: The difference between the promised yield on a corporate bond and the yield of comparable T-bond. Yield spreads tend to be wider during economic recession.

Credit Risk and Collateralized Debt Obligations (CDOs)

Major mechanism to reallocate credit risk in the fixed-income markets Structured Investment Vehicle (SIV) often used to create the CDO