Chapter 2: Pricing of Bonds

Complications (continued) with more shit on it

Complications (continued) with more shit on it

-the expected cash flows -the appropriate required yield

Determining the price of any financial instrument requires an estimate of

A bonds price changes in the opposite direction from the change in the required yield. The reason is that as the required yield increases (decreases0, the present value of the cash flow decreases (increases)

Notes

Premium

a bond whose price is above its par value is said to be selling at a

When an investor purchases a bond between coupon payments, the investor must compensate the seller of the bond for the coupon interest earned from the time of the last coupon payment to the settlement date of the bond

accrued interest

The price of a bond without accrued interest is called

clean price

The security from which the inverse floater is created is called the

collateral

accrued interest is based on a 360-day year, with each month having 30 days

corporate and municipal bonds

For both types of bonds (par or discount) the price will equal what at the maturity date

par value

Also this ***** always uses semiannual bonds and never specifies it at all so keep that in mind

Also this ***** always uses semiannual bonds and never specifies it at all so keep that in mind

Accrued interest is the amount that a bond buyer who purchases a bond between coupon payments must pay the bond seller. The amount represents the coupon interest earned from the time of the last coupon payment to the settlement date of the bond.

Notes

The price of an inverse floater depends on the price of the collateral from which it is created and the price of the floater.

Notes

Discount

When a bond sells below its par value, it is said to be selling at a

What equals the collaterals price minus the floaters price

inverse floater

a floater may have a maximum coupon rate called a what or a minimum coupon rate called a what

-cap -floor

Reasons for the change in the price of a bond (Look at slide for more detail if needed) (Bonds with only a fixed coupon rate)

-change credit quality of the issuer -change in the time to maturity of a bond -change in the required yield

From the collateral needed to make an inverse floater what two bonds are created

-floater -inverse floater

The Cash Flow is not known for what two types of securities and what does it depend on

-floating rate -inverse floating rate Depends on the reference rate in the future

Complications

-next coupon payment isn't exactly six months (semiannually) -cash flows are unknown -appropriate required yield may not be known -wont have the same discount rate for all coupons

A bond will be priced below, at par, or above par depending the bond's coupon rate and the required yield required by investors. When the coupon rate is equal to the required yield, the bond will sell at its par value. When the coupon rate is less (greater) than the required yield, the bond will sell for less (more) than its par value.

Notes

For a zero-coupon bond, there are no coupon payments.The price of a zero-coupon bond is equal to the present value of the maturity value, where the number of periods used to compute the present value is double the number of years and the discount rate is a semiannual yield

Notes

Over time, the price of a premium or discount bond will change even if the required yield does not change.Assuming that the credit quality of the issuer is unchanged, the price change on any bond can be decomposed into a portion attributable to a change in the required yield and a portion attributable to the time path of the bond.

Notes

The price of a bond is the present value of the bond's expected cash flows, the discount rate being equal to the yield offered on comparable bonds. For an option-free bond, the cash flows are the coupon payments and the par value or maturity value. The higher (lower) the required yield, the lower (higher) the price of a bond.

Notes

The price of a floating-rate bond will trade close to par valueif the spread required by the market does not change and there are no restrictions on the coupon rate.

Notes

The discount bond increases in price as it approaches maturity, assuming that the required yield does not change

Notes For a premium bond the opposite occurs

The discount bond increases in price as it approaches maturity, assuming that the required yield does not change.

Notes For a premium bond, the opposite occurs. For both bonds, the price will equal par value at the maturity date.

The amount that the buyer pays the seller is the agreed-upon price plus accrued interest

The amount that the buyer pays the seller is the agreed-upon price plus accrued interest

-periodic coupon interest payments to the maturity date -the par (or maturity) value at maturity

The cash flows for a bond that the issuer cannot retire prior to its stated maturity date consist of

1)The spread over the reference rate 2)any restrictions that may be imposed on the resetting of the coupon rate

The price of a floater depends on

In general, an inverse floater is created from what

fixed rate security

The amount that the buyer pays the seller is the agreed-upon price plus accrued interest

full price or dirty price

A fundamental property of a bond is that its

price changes in the opposite direction from the change in the required yield

The coupon rate of a floating rate of security (or floater) is equal to what plus what

reference rate + spread (margin)

When yields in the marketplace rise above the coupon rate at a given point in time

the price of the bond falls so that an investor buying the bond can realizes capital appreciation

For a bond selling at par value, the coupon rate equals what

the required yield