CHAPTER 14 Investments Bond Prices and Yields Slides by Richard D. Johnson Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Cover image
14- 2 Cover image Face or par value Coupon rate –Zero coupon bond Compounding and payments –Accrued Interest Indenture Bond Characteristics
14- 3 Cover image Different Issuers of Bonds U.S. Treasury –Notes and Bonds Corporations Municipalities International Governments and Corporations Innovative Bonds –Floaters and Inverse Floaters –Asset-Backed –Catastrophe
14- 4 Cover image Figure 14.1 Listing of Treasury Issues
14- 5 Cover image Figure 14.2 Corporate Bond Listings
14- 6 Cover image Secured or unsecured Call provision Convertible provision Put provision (putable bonds) Floating rate bonds Sinking funds Provisions of Bonds
14- 7 Cover image Table 14.1 Principal and Interest Payments for Treasury Inflation Protected Security
14- 8 Cover image P B =Price of the bond C t = interest or coupon payments T = number of periods to maturity y = semi-annual discount rate or the semi-annual yield to maturity Bond Pricing
14- 9 Cover image C t = 40 (SA) P= 1000 T= 20 periods r= 3% (SA) Price: 10-yr, 8% Coupon, Face = $1,000
Cover image Prices and Yields (required rates of return) have an inverse relationship When yields get very high the value of the bond will be very low. When yields approach zero, the value of the bond approaches the sum of the cash flows. Bond Prices and Yields
Cover image Figure 14.3 The Inverse Relationship Between Bond Prices and Yields
Cover image Table 14.2 Bond Prices at Different Interest Rates (8% Coupon Bond, Coupons Paid Semiannually
Cover image Yield to Maturity Interest rate that makes the present value of the bond’s payments equal to its price. Solve the bond formula for r
Cover image Yield to Maturity Example 10 yr MaturityCoupon Rate = 7% Price = $950 Solve for r = semiannual rate r = %
Cover image Yield Measures Bond Equivalent Yield 7.72% = 3.86% x 2 Effective Annual Yield (1.0386) = 7.88% Current Yield Annual Interest / Market Price $70 / $950 = 7.37 % Yield to Call
Cover image Figure 14.4 Bond Prices: Callable and Straight Debt
Cover image Example 14.4 Yield to Call
Cover image Realized Yield versus YTM Reinvestment Assumptions Holding Period Return –Changes in rates affects returns –Reinvestment of coupon payments –Change in price of the bond
Cover image Figure 14.5 Growth of Invested Funds
Cover image Figure 14.6 Prices over Time of 30-Year Maturity, 6.5% Coupon Bonds
Cover image Holding-Period Return: Single Period HPR = [ I + ( P 0 - P 1 )] / P 0 where I = interest payment P 1 = price in one period P 0 = purchase price
Cover image Holding-Period Example CR = 8% YTM = 8%N=10 years Semiannual CompoundingP 0 = $1000 In six months the rate falls to 7% P 1 = $ HPR = [40 + ( )] / 1000 HPR = 10.85% (semiannual)
Cover image Figure 14.7 The Price of a 30-Year Zero-Coupon Bond over Time at a Yield to Maturity of 10%
Cover image Rating companies –Moody’s Investor Service –Standard & Poor’s –Fitch Rating Categories –Investment grade –Speculative grade Default Risk and Ratings
Cover image Figure 14.8 Definitions of Each Bond Rating Class
Cover image Coverage ratios Leverage ratios Liquidity ratios Profitability ratios Cash flow to debt Factors Used by Rating Companies
Cover image Table 14.3 Financial Ratios and Default Risk by Rating Class, Long-Term Debt
Cover image Figure 14.9 Discriminant Analysis
Cover image Sinking funds Subordination of future debt Dividend restrictions Collateral Protection Against Default
Cover image Figure Callable Bond Issue by Mobil
Cover image Default Risk and Yield Risk structure of interest rates Default premiums –Yields compared to ratings –Yield spreads over business cycles
Cover image Figure Yields on Long-Term Bonds, 1954 – 2006