S10: Bond Valuation

Question 1

Determining Bond Yields: Calculator Steps

Answer 1

N = years to maturity * 2
PV = bond ask price
PMT = face value of bond * coupon rate (%) * 1/2
FV = face value of bond
I/Y = <CPT> * 2 -> This is the annual yield</CPT>

Question 2

Determining Bond Prices: Calculator Steps

Answer 2

N = years to maturity * 2
I/Y = annual % yield * 1/2
PMT = face value of bond * coupon rate (%) * 1/2
FV = face value of bond
PV = <CPT> -> This is the bond ask price</CPT>

Question 3

Current Yield (NOT YTM)

Answer 3

Annual Coupon/Price -> Tells annual coupon payment as a % of the price you pay. Annual coupon = Face value * Coupon rate

Question 4

Premium Bonds

Answer 4

Coupon rate > Current Yield > YTM

Price > Par

Question 5

Discount Bonds

Answer 5

Coupon rate < Current Yield < YTM

Price < Par

Question 6

Bonds with similar risk and structure (maturity, callability, etc.)

Answer 6

Have prices in market such that they will yield about the same return, regardless of the coupon rate (Ex: lows and home depot)

Question 7

St. Louis FED’s FRED

Answer 7

Website where we can find current and historical bond yields for corporate and government issuers - gives us estimates of appropriate discount rates to use in our bond valuations

Question 8

What factors influence bond yields?

Answer 8

Interest rate risk, credit or default risk, liquidity risk, inflation risk

Question 9

Interest Rate Risk

Answer 9

The risk that rising interest rates will reduce the value of bonds you hold (ex: you hold a 5% bond but IR in economy goes up to 7%)

Question 10

Credit/Default Risk

Answer 10

Risk that bond issuer will be unable to pay the coupons or principal (high risk, high yield)

Question 11

Liquidity Risk

Answer 11

Risk that your bond can’t be sold quickly without significant loss to value (Sell at a discount less than par value)

Question 12

Inflation Risk

Answer 12

Risk that rising prices will erode the purchasing power of your bond’s coupon payments

Question 13

Nominal Rates (Inflation Risk)

Answer 13

The quoted rates of interest and return that provide the actual return in dollars

Question 14

Real Rates (Inflation Risk)

Answer 14

Returns in terms of purchasing power, inclusive of the effects of inflation

Question 15

Fisher Effect (Inflation Risk)

Answer 15

Shows relationship between nominal rates (R), real rates (r), and inflation rate (h)