Time Influence on Valuation Flashcards
Price (intrinsic value) of a bond is equal to
present value of future cashflows (interest and principal)
Interest and principal on a bond are discounted back to the present at the what
at the going yield (IRR) of comparable debt
When interest rates go up the required yield must do what
go up
Calc value of $1,000 bond, 10% semiannual coupon, 3 year bond - selling at par
PMT = 50
FV = 1000
N = 6 (3 yrs x 2 per year)
I = 5 (10% annual)
Solve for PV
PV = 1000
Calc value of $1,000 bond, 10% semiannual coupon, 3 year bond - selling at a discount
PMT = 50
FV = 1000
N = 6 (3 yrs x 2 per year)
I = 6 (12% annual)
Solve for PV
PV = 950.83
Discounted because of rising interest rates
Calc value of $1,000 bond, 10% semiannual coupon, 3 year bond - selling at a premium
PMT = 50
FV = 1000
N = 6 (3 yrs x 2 per year)
I = 4 (8% annual)
Solve for PV
PV = 1052.42
Premium is result of interest rates declining
2 factors that will increase bond fluctuation
lower coupons and longer term to maturity
Zero Coupon Bond Pricing
PMT= 0
FV = 1000
N = 10
I = 7
Solve for PV
PV = $508
What is the risk in owning a bond?
whether or not you will actually receive the bond payments in the future - DEFAULT RISK
Higher bond default risk means what re: yield
Higher yield
Longer duration of bond means what re: default risk
default risk is higher - the longer the time the higher the default risk
Duration is
weighted average time it takes to collect all cash flows from a bond - weights the present value of each payment by the timing of the payment
Duration measures
price volatility or sensitivity to interest rate changes - the sooner you get your money, the less volatile the value of the bond
Larger Duration value means what
greater the price volatility
Duration facilitates the comparison of what
price volatility of bonds with different coupon rates and different terms to maturity
