Chapter 7

Price and yield A 6% semiannual coupon bond matures in 5 years. The bond has a face value of $1,000 and a current yield of 6.7798%. What is the bond's price? What is the bonds YTM?

Bonds Price: Annual coupon payment= $1000*6%=$60 Current Yield= 6.7798% $60/6.7798%= $884.98 YTM: N= 10 (NPER) PMT= $30 (semi annual coupon payment) PV=$884.98 (Bond Price) FV=$1000 (Face Value) I/Y= 4.45% *2 I/Y= 8.90%

Capitol gains yield

Expected capital gains yield can be found as the difference between YTM and the current yield. YTM - CY

Price Risk

the concern that rising rd will cause the value of a bond to fall

Junk Bonds

BB or lower, high risk, high yield

Investment grade bonds

BBB or higher

Effect of a Call Prevision

-Allows issuer to refund the bond issue if rates decline (helps the issuer, but hurts the investor). -Bond investors require higher yields on callable bonds; AND/ OR a premium above par -In many cases, callable bonds include a deferred call provision (issuer can't call immediately) and a declining call premium (cost too issuer to call EX. $100 + $1000 Par.)

Calculating the Bonds Price

Annual Coupon Payment / Current Yield

Calculating Annual and semi annual coupon payment

Annual coupon payment= Bonds Face Value ($1000) * Interest Rate (10%) =$100 Semi annually= $100/2=$50

Harrimon Industries bonds have 5 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 10%. A) What is the yield to maturity at a current market price of: 1. $879? 2. 1,169? B) Would you pay $879 for each bond if you thought that a "fair" market interest rate for such bonds was 12%-that is, if rd = 12%?

M = $1,000. PMT = 0.10($1,000) = $100. 1. VB = $879: Input N = 5, PV = -879, PMT = 100, FV = 1000, YTM = I/YR = ? I/YR = 13.48%. 2. Replace PV to -$1,169 =5.99% B)Yes. At a price of $879, the yield to maturity, 13.48%, is greater than your required rate of return of 12%. If your required rate of return were 12%, you should be willing to buy the bond at any price below $927.90.

A firm's bonds have a maturity of 14 years with a $1,000 face value, have an 8% semiannual coupon, are callable in 7 years at $1,076, and currently sell at a price of $1,138.51. What is the nominal YTM? What is the Nominal YTC?

N = 14 x 2 = 28; PV = -1,138.51; PMT = 0.08/2 x 1,000 = 40; FV= 1,000; I/YR= YTM = ? YTM = 3.24% x 2 = 6.48%. N = 7 x 2 = 14; PV = -1,138.51; PMT = 0.08/2 x 1,000 = 40; FV = 1,076; I/YR = YTC = ? YTC = 3.195% x 2 = 6.39%. Since the YTC is less than the YTM, investors would expect the bonds to be called and to earn the YTC. (The bonds sell at a premium indicating that interest rates have declined since the bonds were issued; therefore, the bonds would likely be called if interest rates remain lower than the coupon rate.)

Bond valuation Nesmith Corporation's outstanding bonds have a $1,000 par value, a 11% semiannual coupon, 19 years to maturity, and an 8% YTM. What is the bond's price?

N = 2 x 19 = 38; I/YR = 8%/2 = 4%; PMT = (0.11/2) x 1,000 = 55; FV = 1000. solve for PV = $1,290.52.

Six years ago the Templeton Company issued 26-year bonds with a 15% annual coupon rate at their $1,000 par value. The bonds had a 9% call premium, with 5 years of call protection. Today Templeton called the bonds. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called.

N = 6 (Six years ago); PV = -1000; PMT = 150; FV = 1,090; I/YR = ? Solve for I/YR = 16.00%. Despite a 16.00% return on the bonds, investors are not likely to be happy that they were called. Because if the bonds have been called, this indicates that interest rates have fallen sufficiently that the YTC is less than the YTM. (Since they were originally sold at par, the YTM at issuance = 15%.) Rates are sufficiently low to justify the call. Now investors must reinvest their funds in a much lower interest rate environment.

Pelzer Printing Inc. has bonds outstanding with 9 years left to maturity. The bonds have an 8% annual coupon rate and were issued 1 year ago at their par value of $1,000. However, due to changes in interest rates, the bond's market price has fallen to $917.30. The capital gains yield last year was -8.27%. What is the yield to maturity?

N = 9, PV = -917.30, PMT = 80.00, FV = 1,000 I/YR = YTM = 9.402%.

Current Yield

The current yield is defined as the annual coupon payment divided by the current price.

Reinvestment Risk

The risk that a decline in interest rates will lead to a decline in income from a bond portfolio

Calculating the Yield To Maturity (YTM) (Semi Annual)

YTM is the rate of return earned on a bond if it is held to maturity N=NPER PMT=Semi Annual coupon payment PV=Bonds Price FV= Face Value Solve for I/Y and THEN MULTIPLY THE I/Y BY TWO FOR YTM

Mortgage Bonds

bonds backed by fixed assets

Subordinated debentures

bonds having a claim on assets only after the senior debt has been paid in full in the event of liquidation

Debentures

long term bond not secured by mortgage