Bond Valuation Flashcards
Coupon payments
fixed payments made to the investor every six months
Par Value
cash payment made to the investor at the maturity of a bond
Bond prices are _____ related to interest rates
negatively related
Bond price increases when
the required return is lower
Bond prices decrease when
interest rates are higher
Bond prices have to incorporate this change in interest rate
to this changed yield – balance
where bonds are sold:
primary market
secondary market
primary market
sales of newly issued bonds are referred to as primary market transactions
-these bonds are almost always issued at par
secondary market
once the bond has been issued, it can be bought and sold on the secondary market
prices in the secondary market fluctuate based on
changes in the required return of the bon d
prices in the secondary market are quoted per
$100 of bond price
source of return in bonds!
- coupon payments
- price appreciation
- reinvestment income
coupon payments
contractually required semi-annual payments
price appreciation
required return on the bond decreases
reinvestment income
reinvesting coupon income
sources of risk in bonds!
- credit risk
- price decline
- reinvestment risk
credit risk
risk that the investor defaults
price decline
required rate on the bond increase, thus lowering the price of outsanding bonds
reinvestment risk
interest rates decline, and thus the rate you return on your reinvested coupons declines
two components of price risk in bonds
market risk
company specific risk
market risk
interest rates in the aggregate increase or average risk premiums increase
- base interest rates (EX: LIBOR, SOFR, Fed Funds Rate) change
- average risk premium on comparably rated bonds change
market risk impacts…
ALL issuing entities: changes in base interest rates or average risk premium
* interest rates in economy change, bond in market changes*
Company specific risk
the Company is viewed as a higher risk (rating agency downgrade), and thus requires a higher return
idiosyncratic-company specific- apple bond
Reasons the Fed Changes Rates
increases in rates
decreases in rates
increases in rates
typically used to fight inflation
-higher rates lead to higher costs to finance expenditures
-this leads to lower aggregate demand in the economy
-lower demand, with supply held constant, reduces prices (inflation)
increase in rates causes
economic stagnation
decreases in rates
typically used to spur the economy
-lower rates leads to it being cheaper to borrow money for expenditures (both individuals and corporations)
-this leads to increased economic activity
decreases in rates can lead to
inflation
Bond pricing
-Bonds are issued at par
at par:
its price is equal to its face value
all bonds are issued at par. meaning that the
coupon payment= required return * par value
If the bonds required return decreases,
price increases and thus it is trading at a premium
trading at a premium:
its price is greater than face value
if the bonds required return increases
price decreases and thus it is trading at a discount
