Bond Concepts

In: Business and Management

Submitted By farhadtariq
Words 2611
Pages 11
Bond Concepts: Bond Pricing
It is important for prospective bond buyers to know how to determine the price of a bond because it will indicate the yield received should the bond be purchased. In this section, we will run through some bond price calculations for various types of bond instruments. Bonds can be priced at a premium, discount, or at par. If the bond's price is higher than its par value, it will sell at a premium because its interest rate is higher than current prevailing rates. If the bond's price is lower than its par value, the bond will sell at a discount because its interest rate is lower than current prevailing interest rates. When you calculate the price of a bond, you are calculating the maximum price you would want to pay for the bond, given the bond's coupon rate in comparison to the average rate most investors are currently receiving in the bond market. Required yield or required rate of return is the interest rate that a security needs to offer in order to encourage investors to purchase it. Usually the required yield on a bond is equal to or greater than the current prevailing interest rates. Fundamentally, however, the price of a bond is the sum of the present values of all expected couponpayments plus the present value of the par value at maturity. Calculating bond price is simple: all we are doing is discounting the known future cash flows. Remember that to calculate present value (PV) - which is based on the assumption that each payment is re-invested at some interest rate once it is received--we have to know the interest rate that would earn us a known future value. For bond pricing, this interest rate is the required yield. Here is the formula for calculating a bond's price, which uses the basic present value (PV) formula:

C = coupon payment n = number of payments i = interest rate, or required yield M = value at maturity, or par…...

Similar Documents

Chemical Bonds

...CHEMICAL BONDS Chemical Bonds I. Introduction Chemical compounds are formed by the joining of two or more atoms. A stable compound occurs when the total energy of the combination has lower energy than the separated atoms. The bound state implies a net attractive force between the atoms called a chemical bond. The two extreme cases of chemical bonds are the covalent bonds and ionic bonds. Covalent bonds are bonds in which one or more pairs of electrons are shared by two atoms. Covalent bonds, in which the sharing of the electron pair is unequal, with the electrons spending more time around the more non-metallic atom, are called polar covalent bonds. In such a bond there is a charge separation with one atom being slightly more positive and the other more negative, i.e., the bond will produce a dipole moment. On the other hand, Ionic bonds are bonds in which one or more electrons from one atom are removed and attached to another atom, resulting in positive and negative ions which attract each other. In the extreme case where one or more atoms lose electrons and other atoms gain them in order to produce a noble gas electron configuration, the bond is called an ionic bond. Covalent bonding is a form of chemical bonding between two non-metallic atoms which is characterized by the sharing of pairs of electrons between atoms and other covalent bonds. Ionic bond, also known as electrovalent bond is a type of bond formed from the electrostatic attraction between oppositely......

Words: 1310 - Pages: 6

Bond Valuation

...BOND VALUATION Bond Bond is a long term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond Key characteristics: VB = value of a bond/bond price M = par or maturity value of the bond; it is the stated face value of the bond and this is amount that must be paid off at maturity and it is often equal to $ 1.000 INT = coupon payment or dollars of interest paid each year; (Coupon rate x Par value) rk = coupon interest rate; (coupon payment / par value) rd = the bond's required rate of the return; that is the market rate of interest for that type of bond; it is also called the yield N = number of years before the bond matures; maturity date is a date on which the par value must be repaid m = number of discounting periods per year The value of any financial asset - a stock, a bond, a lease, or even a physical asset such as an apartment building is simply the present value of the cash flows the asset is expected to produce. Bond Valuation The cash flows from a specific bond depend on the contractual features meaning the type of the bond. The following general equation, written in several forms, can be used to find the value of any bond, VB. = (1 + ) + (1 + ) + ⋯+ ) (1 + + ) + (1 + ∙ ) = (1 + So, the cash flows consist of an annuity of N years plus a lump sum payment at the end of Year N. 1. Standard coupon-bearing bond Standard coupon-bearing bond =the cash flows consist of interest payment......

Words: 3870 - Pages: 16


...Bonds are appealing to investors because they provide a generous amount of current income and they can often generate large capital gains. These two sources of income together can lead to attractive and highly competitive investor returns. Bonds make an attractive investment outlet because of their versatility. They can provide a conservative investor with high current income or they can be used aggressively by investors who prefer capital gains. Given the wide and frequent swings in interest rates, investors can find a variety of investment opportunities. In addition to their versatility, certain types of bonds can be used to shelter income from taxes. While municipal bonds are perhaps the best known tax shelters, some Treasury and federal agency bonds also give investors some tax advantages. Bonds are exposed to the following five major types of risk: (1) Interest rate risk: This affects the market as a whole and therefore translates into market risk. When market interest rates rise, bond prices fall, and vice versa. (2) Purchasing power risk: This is the risk caused by inflation. When inflation heats up, bond yields lag behind inflation rates. A bond investor is locked into a fixed-coupon bond even though market yields are rising with inflation. (3) Business/financial risk: This refers to the risk that the issuer will default on interest and/or principal payments. Business risk is related to the quality and integrity of the issuer, whereas financial risk relates to the......

Words: 15669 - Pages: 63


...------------------------------------------------- Top of Form Bottom of Form * Bond Markets / Prices * Commentary * Learn More * Overview * Bond Basics * What You Should Know * Buying and Selling Bonds * Types of Bonds * Strategies * Bonds at Your Stage of Life * About Municipal Bonds * About Government/Agency Bonds * About Corporate Bonds * About MBS/ABS * How to Use This Site * Links to Other Sites Learn More * Overview * Bond Basics * What You Should Know * Overview * The Role of Bonds in America * Investor's Checklist * Investor Protection * Asset Allocation * Reading Bond Prices In the Newspaper * Understanding Economic Statistics * Bond and Bond Funds * Risks of Investing in Bonds * Rating Changes and Your Investments * Corporate Bankruptcy & Your Investment * Selecting and Working with a Financial Professional * Rising Rates and Your Investments * Tax Tables * Buying and Selling Bonds * Types of Bonds * Strategies * Bonds at Your Stage of Life * About Municipal Bonds * About Government/Agency Bonds * About Corporate Bonds * About MBS/ABS * How to Use This Site * Links to Other Sites What You Should Know * Print   * Email Risks of Investing in Bonds All investments offer a balance between risk and......

Words: 2099 - Pages: 9

Bond Valuation

...Bond Valuation By Anuj Joshi Note 1 Bond Valuation Fixed income paying securities. 1. Theoretical price or value of bond depends upon. i. Coupon Payment : Fixed amount of interest to be received after prescribed frequency. ii. Maturity Value [Unless otherwise given is exam, we should take face value] iii. Discount Rate : It should always be market interest rate 2. What is market interest rate Market interest rate is derived from comparable listed bond. The comparison is based on risk and life of the bond. E.g. If we are valuing a bond which is unlisted and have 5 years of life, then we should look for a bond which is similar in risk profile (i.e. same credit rating)and having similar life. The YTM (Yield to Maturity) of listed bond is called market interest rate The YTM of a bond is nothing but IRR of the bond. 3. Value of a bond = PV of Coupon Amount + PV of Maturity Value [Remember CF and discount rate are before tax] Concept Point: i. Coupon rate is a historical rate and should never be used as a discount rate. In exam, if no other information is available, then only we should assume coupon rate of interest as market rate of interest. ii. Remember, Cost of Capital or Discount Rate is a future concept and it represents opportunity cost on the date of valuation. iii. YTM of a similar bond (i.e. current market interest rate) is the appropriate discount rate for bond valuation. How to value a bond which pays interest at a frequency lower than annually (e...

Words: 2748 - Pages: 11


...Vincent Murphy 4/14/14 There are many great ways to invest your hard earned money; this can be done through stocks and bonds. With stocks and bonds you can invest in companies, governments or even your local bank. In this report I will tell three of the most common and efficient ways to invest your finances, They are common stock, preferred stock and company bonds. Common stock allows you to be a part owner of a company along with other stock holders. Being a part owner comes with one major benefit, the ability to elect the board of directors. Lastly you could potentially earn dividends paid out by the company. Unlike preferred stocks the dividend that are not promised to common stock holders. This now brings me to the second popular investment tool Preferred stocks. With preferred stocks you are not the owner of the company, this means you have no voting rights. Even though you are not an owner you do receive preferential treatment in receiving dividends. This means that the company that you own stock in will ensure that you receive dividends before the common stock owners. Lastly, another incentive for owning preferred stock is that the dividends are given at a fixed rate. The last investment option I will talk about is company bonds. Company bonds work off of collateral, to help insure you get your money if the company fails. There is two types of collateral, mortgage and equipment. With mortgage collateral if anything was to happen to the company you would......

Words: 390 - Pages: 2


...-In order to understand the effect of issuing and refinancing bonds, I want to present you with some important bond basics. -So what’s the goal of a bond? -Companies issue bonds to create debt for its company. -For example, maybe the company needs to finance a project and needs immediate capital. -So the goal is to borrow money for a given period of time, specified in the contract. -So what does the company have to give up? -Must pay interest each period -Must repay the face value of the bond at the end of the period. -Bonds can be sold at a discount, a premium, or par value -If the bond is sold at a premium, the bond costs more than the face value of the bond -Thus the company will increase the interest offered over market rate -If the bond is sold at a discount, the bond costs less than the face value of the bond. -Thus the company will decrease the interest offered over market rate. -And of course, par means it is sold at the face value. -Liability is the whole amount of the bond that the company owes at the time in question. -As we will soon see, because the prevailing market rate for bonds has decreased over recent years, Lyons will have the opportunity to buyback the old bonds and offer new bonds at a lowest interest rate. -I will now pass it to Aditya who will further discuss the specifics of the original bond issue....

Words: 254 - Pages: 2


...the property dividend is declared 31 Property Dividends - Example At date of declaration (for Investment which cost 1,250,000 but value 2,000,000) Investment in Securities 750,000 Gain in Appreciation 750,000 Retained Earnings 2,000,000 Property Dividends Payable 2,000,000 Record date – no entry Payment date Property Dividends Payable 2,000,000 Investments in Securities 2,000,000 32 Liquidating Dividends Dividend distribution is based on corporate paid-in capital instead of earnings, which implies a return of investments At date of declaration Retained Earnings 900,000 Additional Paid-in Capital 300,000 Dividends Payable 1,200,000 Record date – no entry Payment date Dividends Payable 1,200,000 Cash 1,200,000 33 Stock Dividends - concepts  Stock dividends result in more shares being issued as dividend (no cash flow is involved).  Small stock dividends involve issues of less than 20%–25% of stock.  The accounting for small stock dividends is based on the fair market value of stock issued.  The accounting for large stock dividends (more than 20%–25%) is based on the par value of stock issued. 34 Small Stock Dividends - example For each 10 shares outstanding, distribute 2 shares. Par value of the share is $10 and market value is $13. There are 5,000 shares outstanding. At date of declaration Retained Earnings Common Stock Dividend Distributable Paid-in Capital in Excess of Par Record date – no entry Distribution date Common Stock Dividend Distributable Common Stock ...

Words: 2210 - Pages: 9

Bond Market

...Bond Market INTRODUCTION Presently, as there is a robust growth of industrial activity in our economy, the need for investment has grown significantly and has resulted in a strong credit growth Some disintermediation is expected to take place as the most creditworthy borrower seeks the lowest borrowing costs. This development has re-emphasized the fact that bond financing has to supplement the traditional bank financing to take care of the growing credit needs of the economy. The Indian debt market, particularly the government securities market, has undergone a significant transformation since the introduction of reforms in the financial markets in 1991-92. The primary objective behind the reforms has been to moderate liquidity growth, contain inflationary pressure, and conduct public debt management in a cost-effective manner. Various reforms have also been undertaken in the corporate debt market. The corporate bond market is an important segment of the financial market in terms of funds raised well as potential for future growth. The Securities and Exchange Board of India (SEBI) was established in 1992, to regulate the primary issue in equity and de markets and to ensure sound trading practices in the secondary market throu stock exchanges. The bond market is an important source of funding for both t government and corporate sector. The bond market, also known as the debt, credit, or fixed income market, is a market where participants buy and sell debt......

Words: 6265 - Pages: 26


... 07/24/2011 5.1 Jackson Corporation's bonds have 12 years remaining to maturity. Interest is paid annually...? Jackson Corporation's bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 9%. What is the market price of these bonds? Solution:- Rate = 9% Nper =12 PMT = 1000x8%=-80 FV = -1,000 PV = ? Solve for PV PV = $928.39 Market Price of the bond = $928.39 5-2-Wilson Wonders’s bond have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 10%. The bonds sell at a price of $850. What is their yield to maturity? USING A BOND YOELD CALCULATOR Current Price = $850 Par Value = $1000 Coupon Rate = 10% Years t5o Maturity = 12 Years CALCULATION RESULT Current Yield = 11.765 Yield to Maturity = 12.48 5-6. The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2- year Treasury security yields 6.3 % . What is the maturity risk premium for the two year security? K= K* + IP + DRP + LP + MRP KT-2 = 6.3% = 3% +3% + MRP; DRP=LP=0 MRP = 6.3%-6% MRP=0.3% 5-7. Renfro Rentals has issued bonds that have a 10%coupon rate, payable semiannually. The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity of 8.5%. What is the price of the bonds? Answer:- FV =1,000, PMT= 50, N= 16, R=......

Words: 456 - Pages: 2

Bond Valuation

...Financial Management  Unit 4  Unit 4  4.1  Introduction  4.2  Valuation of Bonds  Types of Bonds  4.2.1  Irredeemable or Perpetual Bonds  Valuation Of Bonds And Shares  4.2.2  Redeemable or Bonds with Maturity Period  4.2.3  Zero Coupon Bond  Bond­yield Measures  4.2.1  Holding Period Rate of Return  4.2.2  Current Yield  4.2.3  Yield to Maturity (YTM)  4.2.4  Bond Value Theorems  4.3  Valuation of Shares  4.3.1  Valuation of Preference Shares  4.3.2  Valuation of Ordinary Shares  4.4  Summary  Solved Problems  Terminal Questions  Answers to SAQs and TQs  4.1  Introduction  Valuation is the process of linking risk with returns to determine the worth of an asset. Assets can be  real or financial; securities are called financial assets, physical assets are real assets. The ultimate  goal  of  any  individual  investor  is  maximization  of  profits.  Investment  management  is  a  continuous  process requiring constant monitoring. The value of an asset depends on the cash flow it is expected  to provide  over  the  holding period.  The fact  that as  on date  there  is no  method  by  which  prices  of  shares  and  bonds  can  be  accurately  predicted  should  be  kept  in  mind  by  an  investor  before  he  decides  to  take  an  investment  decision.  The  present  chapter  will  help  us  to  know  why  some Sikkim Manipal University  50  Financial Management  Unit 4  securities  are  priced  higher  than  others. We  can  design ......

Words: 3016 - Pages: 13

Muncipal Bonds

...Municipal Bond Market Development Edited and with an introduction by: Priscilla Phelps, Senior Finance Advisor, Research Triangle Institute November 1997 Environmental and Urban Programs Support Project Project No. 940-1008 Contract No. PCE-1008-I-00-6005-00 Contract Task Order No. 06 Conducted by Research Triangle Institute Sponsored by the United States Agency for International Development Office of Environment and Urban Programs (G/ENV/UP) COTR Sarah Wines Finance Working Papers Table of Contents Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v Part I: Municipal Bond Market Development in Developing Countries: The Experience of the U.S. Agency for International Development . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 The Changing Situation of Local Governments and Their Financing Options . . . . . 4 Defining Municipal Financial Market Development . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Strategic Context for Municipal Bond Market Development at USAID . . . . . . . . . . . 8 Technical Summary of Municipal Bond Projects . . . . . . . . . . . . . . . . . . . . . . . . . . 10 USAID......

Words: 43244 - Pages: 173


...BONDS AND SINKING FUNDS Amortization of Bond Premiums and Discounts *APPENDIX: The origin and calculation of bond premiums and discounts were discussed in Section 15.2. We will now look at the premiums and discounts from an accountant’s perspective. The point of view and the schedules developed here provide the basis for the accounting treatment of bond premiums, discounts, and interest payments. Amortization of a Bond’s Premium Bonds are priced at a premium when the coupon rate exceeds the yield to maturity required in the bond market. Suppose that a bond paying a 10% coupon rate is purchased three years before maturity to yield 8% compounded semiannually. The purchase price that provides this yield to maturity is $1052.42. The accounting view is that a period’s earned interest is the amount that gives the required rate of return on the bond investment. The interest payment after the first six months that would, by itself, provide the required rate of return (8% compounded semiannually) on the amount invested is 0.08 ϫ $1052.42 ϭ $42.10 2 The earned interest during the first six months from an accounting point of view is $42.10. The actual first coupon payment of $50 pays $50 Ϫ $42.10 ϭ $7.90 more than is necessary to provide the required rate of return for the first six months.7 The $7.90 is regarded as a refund of a portion of the original premium, leaving a net investment (called the bond’s book value) of $1052.42 Ϫ $7.90 ϭ $1044.52 This......

Words: 1917 - Pages: 8


... a) Bond – is a long term contract under which the borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond. Treasury bonds – sometimes referred to as government bonds, are issued by the U.S. federal government. These bonds have not default risk. However, these bonds decline when interest rates rise, so they are not free of all risk Corporate bonds – issued by corporate; exposed to default risk – if the issuing company gets into trouble, it may be unable to make the promised interest and principal payments. Different corporate bonds have different levels of default risk, depending on the issuing company’s characteristics and the terms of the specific bond. Default risk often referred to as “credit risk” and the larger the default or credit risk, the higher the interest rate the issuer must pay. Municipal bond – or “munis “ are issued by state and local governments. Like corporate bonds, munis have default risk. Munis offer one major advantage over all the other bonds is exempt from federal taxes and also from state taxes if the holder is a resident of the issuing state. Munis bonds carry interest rates that are considerably lower than those on corporate bonds with the same default risk Foreign bond – are issued by foreign governments or foreign corporations. Foreign corporate bonds are of course exposed to default risk, and so are some foreign government bonds. An additional risk exists if the bonds are......

Words: 1835 - Pages: 8


...FV TVM - INVESTING CONTD. SOLUTIONS STEP 2: WE ARE SOLVING FOR I/Y P/Y =12 NOTE: since you are saving MONTHLY, you must set P/Y to 12 N = 15 X 12 = 180 PV = -100000 PMT = -500 FV = 1500000 SOLVE FOR I/Y = 16.20% 12. USING BOND SPREADSHEET (covered later in course). You want to buy an A rated bond that matures in 15 years. The coupon rate is 8%. The yield on A rated bonds in the same maturity range is 7.5%. What price would you pay for this bond? Corporate bonds mature at PAR. Par = $1000 • Corporate bonds pay interest coupons SEMIANNUALLY. P/Y = 2 • The stated interest rate on the bond is fixed for the life of the bond. This is called the “Coupon rate.” • All bonds are priced to the market yield on bonds of similar type, quality and maturity. This yield is always changing and bonds adjust to it by the price fluctuating. If yields in the market go UP, bond prices go DOWN. SET BGN SET P/Y = 2 N = 30 (Remember N = P/Y times the number of years) I/Y = 7.5 In a bond problem I/Y is the yield on other similar bonds. DO NOT use the coupon rate on the bond. FV = 1000 All bonds mature at par. Par = 1000 PMT = 40 Bonds pay interest semiannually. This bond has a coupon rate of 8%. Annual interest = 8% x $1000 = $80 Each coupon is therefore half the annual interest of $80 or $40 SOLVE FOR PV 1071.32 PROBLEM A loan of $50,000 is due 10 years from today. The...

Words: 1716 - Pages: 7