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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.

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Presentation on theme: "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."— Presentation transcript:

1 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

2 14- 2 Cover image  Face or par value  Coupon rate –Zero coupon bond  Compounding and payments –Accrued Interest  Indenture Bond Characteristics

3 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

4 14- 4 Cover image Figure 14.1 Listing of Treasury Issues

5 14- 5 Cover image Figure 14.2 Corporate Bond Listings

6 14- 6 Cover image  Secured or unsecured  Call provision  Convertible provision  Put provision (putable bonds)  Floating rate bonds  Sinking funds Provisions of Bonds

7 14- 7 Cover image Table 14.1 Principal and Interest Payments for Treasury Inflation Protected Security

8 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

9 14- 9 Cover image C t = 40 (SA) P= 1000 T= 20 periods r= 3% (SA) Price: 10-yr, 8% Coupon, Face = $1,000

10 14- 10 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

11 14- 11 Cover image Figure 14.3 The Inverse Relationship Between Bond Prices and Yields

12 14- 12 Cover image Table 14.2 Bond Prices at Different Interest Rates (8% Coupon Bond, Coupons Paid Semiannually

13 14- 13 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

14 14- 14 Cover image Yield to Maturity Example 10 yr MaturityCoupon Rate = 7% Price = $950 Solve for r = semiannual rate r = 3.8635%

15 14- 15 Cover image Yield Measures Bond Equivalent Yield 7.72% = 3.86% x 2 Effective Annual Yield (1.0386) 2 - 1 = 7.88% Current Yield Annual Interest / Market Price $70 / $950 = 7.37 % Yield to Call

16 14- 16 Cover image Figure 14.4 Bond Prices: Callable and Straight Debt

17 14- 17 Cover image Example 14.4 Yield to Call

18 14- 18 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

19 14- 19 Cover image Figure 14.5 Growth of Invested Funds

20 14- 20 Cover image Figure 14.6 Prices over Time of 30-Year Maturity, 6.5% Coupon Bonds

21 14- 21 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

22 14- 22 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 = $1068.55 HPR = [40 + ( 1068.55 - 1000)] / 1000 HPR = 10.85% (semiannual)

23 14- 23 Cover image Figure 14.7 The Price of a 30-Year Zero-Coupon Bond over Time at a Yield to Maturity of 10%

24 14- 24 Cover image  Rating companies –Moody’s Investor Service –Standard & Poor’s –Fitch  Rating Categories –Investment grade –Speculative grade Default Risk and Ratings

25 14- 25 Cover image Figure 14.8 Definitions of Each Bond Rating Class

26 14- 26 Cover image  Coverage ratios  Leverage ratios  Liquidity ratios  Profitability ratios  Cash flow to debt Factors Used by Rating Companies

27 14- 27 Cover image Table 14.3 Financial Ratios and Default Risk by Rating Class, Long-Term Debt

28 14- 28 Cover image Figure 14.9 Discriminant Analysis

29 14- 29 Cover image  Sinking funds  Subordination of future debt  Dividend restrictions  Collateral Protection Against Default

30 14- 30 Cover image Figure 14.10 Callable Bond Issue by Mobil

31 14- 31 Cover image Default Risk and Yield  Risk structure of interest rates  Default premiums –Yields compared to ratings –Yield spreads over business cycles

32 14- 32 Cover image Figure 14.11 Yields on Long-Term Bonds, 1954 – 2006

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