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Investments, 8 th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights.

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Presentation on theme: "Investments, 8 th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights."— Presentation transcript:

1 Investments, 8 th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 14 Bond Prices and Yields

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

3 14-3 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 Figure 14.1 Listing of Treasury Issues

5 14-5 Figure 14.2 Listing of Corporate Bonds

6 14-6 Secured or unsecured Call provision Convertible provision Put provision (putable bonds) Floating rate bonds Preferred Stock Provisions of Bonds

7 14-7 Innovation in the Bond Market Inverse Floaters Asset-Backed Bonds Catastrophe Bonds Indexed Bonds

8 14-8 Table 14.1 Principal and Interest Payments for a Treasury Inflation Protected Security

9 14-9 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

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

11 14-11 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

12 14-12 Figure 14.3 The Inverse Relationship Between Bond Prices and Yields

13 14-13 Table 14.2 Bond Prices at Different Interest Rates (8% Coupon Bond, Coupons Paid Semiannually)

14 14-14 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

15 14-15 Yield to Maturity Example 10 yr MaturityCoupon Rate = 7% Price = $950 Solve for r = semiannual rate r = 3.8635%

16 14-16 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

17 14-17 Figure 14.4 Bond Prices: Callable and Straight Debt

18 14-18 Example 14.4 Yield to Call

19 14-19 Realized Yield versus YTM Reinvestment Assumptions Holding Period Return –Changes in rates affect returns –Reinvestment of coupon payments –Change in price of the bond

20 14-20 Figure 14.5 Growth of Invested Funds

21 14-21 Figure 14.6 Prices over Time of 30-Year Maturity, 6.5% Coupon Bonds

22 14-22 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

23 14-23 Holding-Period Return 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)

24 14-24 Figure 14.7 The Price of a 30-Year Zero- Coupon Bond over Time at a Yield to Maturity of 10%

25 14-25 Rating companies –Moody’s Investor Service –Standard & Poor’s –Fitch Rating Categories –Investment grade –Speculative grade/Junk Bonds Default Risk and Ratings

26 14-26 Figure 14.8 Definitions of Each Bond Rating Class

27 14-27 Coverage ratios Leverage ratios Liquidity ratios Profitability ratios Cash flow to debt Factors Used by Rating Companies

28 14-28 Table 14.3 Financial Ratios and Default Risk by Rating Class, Long-Term Debt

29 14-29 Figure 14.9 Discriminant Analysis

30 14-30 Sinking funds Subordination of future debt Dividend restrictions Collateral Protection Against Default

31 14-31 Figure 14.10 Callable Bond Issued by Mobil

32 14-32 Default Risk and Yield Risk structure of interest rates Default premiums –Yields compared to ratings –Yield spreads over business cycles

33 14-33 Figure 14.11 Yields on Long-Term Bonds, 1954 – 2006

34 14-34 Credit Risk and Collateralized Debt Obligations (CDOs) Major mechanism to reallocate credit risk in the fixed-income markets –Structured Investment Vehicle (SIV) often used to create the CDO –Mortgage-backed CDOs were an investment disaster in 2007

35 14-35 Figure 14.12 Collateralized Debt Obligations

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