Chapter 10 Investments Finance

Callable Bond Price Formula

(C/YTC)(1-(1/(1+ YTC/2)^2T)) + CP/(1+(YTC/2)^2T) C= Constant annual coupon CP= Call price of the bond T= Time in years until earliest possible call date YTC= Yield to call assuming semiannual coupons

Discount bonds

Price < Par Value The yield to maturity of a par bond is equal to its coupon rate. Coupon rate < Current Yield < Yield to Maturity

Par bonds

Price = Par Value The yield to maturity of a par bond is equal to its coupon rate. Coupon Rate = Current Yield = Yield to Maturity

Premium bonds

Price > Par Value The yield to maturity of a premium bond is less than its coupon rate Coupon rate > Current Yield > Yield to maturity

Interest Rate Risk

The possibility that changes in interest rates will result in losses in bond's value

Callable bond

a bond is callable if the issuer can buy it back before it matures

current yield

a bond's annual coupon divided by its market price Current yield= annual coupon / bond price

Coupon rate

a bond's annual coupon divided by its par value. Also called coupon yield or nominal yield Coupon rate= annual coupon/par value

yield to call (YTC)

measure of return that assumes a bond will be redeemed at the earliest call date

yield to maturity (YTM)

the discount rate that equates a bond's price with the present value of its future cash flows. Also called promised yield or just yield.

call protection period

the period during which a callable bond cannon be called. Also called a call deferment period

make-whole call price

the present value of the bond's remaining cash flows

dirty price

the price of a bond including accrued interest, also known as the full or invoice price. This is the price the buyer actually pays.

Clean Price

the price of a bond net of accrued interest; this is the price that is typically quoted

call price

the price the issuer of a callable bond must pay to buy it back

realized yield

the yield actually earned or "realized" on a bond