L9 - Bond Price and Yield

Question 1

How can you interpret treasury bond price quotes?

Answer 1

• •For the highlighted bond, read data as follows:
• –Current date: Oct 30, 2009
• –Matures in Oct 2014
• –Par value $1,000, coupon of 2.375% per year
  
  • –Each coupon payment = $1,000 * 2.375% / 2 = $11.875 every six months
• –Bid price = 100:08 = 100+8/32 = 100.25% of par
• –Ask price = 100:09 = 100+9/32 = 100.281% of par
• –Bid-ask spread = 1/32 = 0.03125% of par
• –Change since previous closing: (18/32)% = 0.5625% of par
• –Ask yield = 2.32%, semiannually-compounded APR

Question 2

How do you calculate accrued interest?

Answer 2

• Accrued Interest = Coupon payment for that period *( number of days since last coupon payment/number of days in that period)
• The actual price paid is also called the dirty price.

Question 3

How can you interpret Corporate Bond Listing?

Answer 3

• For the highlighted bond, read data as follows:
  
  • –Current date: Oct 21, 2009
  • –Coupon of 6.3% a year, coupon payments are $31.5 every April and October
  • –Matures on April, 2019, par value $1,000
  • –Rating: Aa3/A+/AA- (Moody’s, S&P, and Fitch)
  • –Last trade price 111.045% of par, or $1110.45
    
    • High, low and last prices are all expressed as percentages
  • –Yield 4.836% (semiannually-compounded APR)

Question 4

What are the 4 types of Corporate Bonds?

Answer 4

• Callable
  
  • Issuer can repurchase the bond at a specified call price before the maturity date
  • –Who enjoys the benefit? Firm or bondholder?
    
    • •When interest rate declines, firm can retire high-coupon debt and issue a lower coupon debt to reduce interest payments
    • •Callable bonds are often issued with higher coupons and promised yields to maturity than non-callable bonds.
• Putable
  
  • Bondholders have the option to retire the bond early or extend its life.
• Convertible
  
  • Bondholders can exchange each bond for a pre-specified number of shares of common stock
  • –Who enjoys the benefit? Firm or bondholder?
    
    • •When the stock price rises, the bondholder can convert their bond to stocks.
    • •Convertible bonds offer lower coupon rates or promised yields to maturity than do nonconvertible bonds. –> but many bondholders don’t really like these because it leads to an added risk for them to accept
• Floating/ Adjusting rate
  
  • Have an adjustable coupon rate (e.g. matching it with inflation or LIBOR + xbps)

Question 5

How do you calculate the Price of a Bond?

Answer 5

Question 6

How are Bond Prices and Interest rate linked?

Answer 6

• There is a negative relationship between the interest rate and bond price. As the interest rate goes up
  
  • ,–Bonds become less attractive since coupon payment is fixed
  • –Weak demand for bonds, so bond prices fall
• If r = coupon rate, par value = bond price
• If r > coupon rate, bond price < par value –> discount bond
• If r < coupon rate, bond price > par value –> premium bond

Question 7

What is the relationship between maturity and market interest rate?

Answer 7

• The longer the maturity the more sensitive the bond’s price to changes in market interest rates
  
  • Longer bonds suffer from larger interest rate risk

Question 8

What is the yield to maturity?

Answer 8

• Make sure you convert the YMT into an APR (so if its a semi-annual rate you need to convert it to an annual one by multiplying by 2)

Question 9

In what situations do the price of callable and straight bonds differ?

Answer 9

• When the interest rate falls, the price of a straight bond can rise considerably.
• •When interest rate is high, the risk of call is negligible. The values of the straight and the callable bond are almost the same.
• •When interest rate is low, there is very high probability that the callable bond will be called.
  
  • –For holders of a callable bond, there is very little difference between “low interest rate” and “very low-interest rate” since the bond will be called anyway.
  • –The price of the callable bond is flat over a range of low interest rates

Question 10

What is the difference between Yield to Call and Yield to Maturity?

Answer 10

• Yield to maturity is the average return if you hold the bond to maturity whereas yield to call is the average return if the bond is held to its call date.

Question 11

What is a Zero coupon bond?

Answer 11

• Provides only one cash flow to their owners on the maturity data of the bond
  
  • T-bills are a short-term zero-coupon instruments
• Long-term zero-coupon bonds are usually created from existing bonds e.g. Treasury strips (Separate Trading of Registered Interest and Principal Securities)

Question 12

What are the main Credit Rating Agencies?

Answer 12

• Rating agencies:
  
  • –Moody’s Investor Service, Standard & Poor’s, Fitch
  • –Assess bond issuers’ default risk and issue credit ratings
• •Rating Categories
  
  • –Highest rating is AAA or Aaa
  • –Investment grade bonds are rated BBB or Baa and above
  • –Speculative grade/junk bonds have ratings below BBB or Baa.