Treasury Bonds Midterm Review.

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Presentation transcript:

Treasury Bonds Midterm Review

Key Factors Determine the Cash Flows Coupon payment is the face value multiplied by the coupon rate divided by the compounding frequency. (PMT) Price or present value (PV) Face value or par value (FV) Yield to maturity divided by the compounding frequency gives the rate (rate) Years to maturity multiplied by the compounding frequency gives n or number of payments (nper) The formula that relates the price of bonds to the present value of the future cash flows is:

Bond Yields and Prices Bourdon Software has 6.4 percent coupon bonds on the market with 18 years to maturity. The bonds make semiannual payments and currently sell for 106.8 percent of par. What is the current yield on the bonds? The YTM? The effective annual yield?

Current Yield The current yield is an approximation of the yield to maturity and is defined as the ration of the coupon payment to the price of the bond. The coupon payment is the coupon rate multiplied by the face value. This is then adjusted for the frequency of the compounding. In this case, the compounding frequency is twice a year.

Yield to Maturity The yield to maturity (YTM) is that discount rate that causes the present value of the future cash flows to be equal to the price of the bond. If we know the future cash flows and the price, then we can calculate the yield to maturity. If we know the future cash flows and the yield to maturity, then we can calculate the price.

Effective Annual Yield The Effective Annual Yield (EAR) takes into consideration compounding and makes interest rates comparable. Annual Percentage Yields (APR) don’t take into consideration compounding.