FNBU 3221 Lecture 10: Chapter 9

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22 Jun 2018

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CHAPTER 9: THE VALUE OF SECURITIES

What is a BOND?

Instrument made up of fixed income (interest payments) with a guaranteed principal repayment

oAssumes no default by the lender

Valuing bonds involves forecasting interest payments and the principal and then discounting

oPV (Bond) = PV (Interest Annuity) + PV (Face Value)

oValuation requires knowing the bond’s yield or the PV

PV = FV when Yield = Coupon

oCoupon = Payment / FV

oPayment = CPN x FV

PV > FV when Yield < Coupon

oRequired rate (yield) is less than what the bond is offering (coupon)

oInvestors are willing to a pay a higher PV (premium) because they can get a higher return

than what the typical market is offering

PV < FV when Yield > Coupon

oRequired rate (yield) is greater than what the bond is offering (coupon)

oInvestors are not willing to pay face value because they can get a higher return at the

typical market rate

YTM and HPY

Yield-to-Maturity (YTM): The rate of return an investor would earn from a bond held until maturity

Holding-Period Yield (HPY): The rate of return an investor actually earns from an investment

oMay be greater than, less than, or equal to YTM, depending on whether interest rates

change

YTM = HPY if the bond is held to maturity (instead of being sold)

Sources of Risk

Business risk is general variability resulting from business operations

Process Risk: Internal risk, controllable

oResults from internal operations, human error, management decisions, etc.

Environmental Risk: External risk, out of the firm’s control

oResults from Δ regulation/policy, Δ consumer preferences, natural disasters, etc.

Stock Valuation

PV (Preferred Stock) = D/r

or = D/PV

PV (Common Stock) = D/(r-g) = D(1+g)/(r-g)

or = D/PV + g

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Document Summary

Instrument made up of fixed income (interest payments) with a guaranteed principal repayment: assumes no default by the lender. Valuing bonds involves forecasting interest payments and the principal and then discounting: pv (bond) = pv (interest annuity) + pv (face value, valuation requires knowing the bond"s yield or the pv. Pv = fv when yield = coupon: coupon = payment / fv, payment = cpn x fv. Yield-to-maturity (ytm): the rate of return an investor would earn from a bond held until maturity. Holding-period yield (hpy): the rate of return an investor actually earns from an investment: may be greater than, less than, or equal to ytm, depending on whether interest rates change. Ytm = hpy if the bond is held to maturity (instead of being sold) Business risk is general variability resulting from business operations. Process risk: internal risk, controllable: results from internal operations, human error, management decisions, etc.

Related Questions

EJ Corp bond carries a 9 percent coupon, paid semi-annually. The par value is $1,000, and the bond matures in 12 years. If the bond currently sells for $905.50 (PV), what is its yield to maturity?

Enter PV as a negative number. Calculate equal 24 payments ($1,000*.09/2) and enter.

Remember the last payment is the return of principal plus PMT. Use IRR(cash flows).

Time	Payment Periods	Cash Flow
Today	0	Pv>= ?
	1	?
	2	?
	3	?
	4	?
	5	?
	6	?
	7	?
	8	?
	9	?
	10	?
	11	?
	12	?
	13	?
	14	?
	15	?
	16	?
	17	?
	18	?
	19	?
	20	?
	21	?
	22	?
	23	?
Add FV to PMT=	24	?

IRR=> ?

The YTM is 2*IRR===> ?

a, You own bonds with 7 years remaining to maturity. The bonds have a $10,000 par value, the coupon payment every year is $375, and the bonds have a yield to maturity of 4.9%. What is the current market price of these bonds?

b, If the bond in question a sold at par (price = face value), explain why the yield to maturity would be the same as the coupon rate.

c, What is the duration of a two-year bond that pays an annual coupon of 5%, returns the face value, and has a current yield to maturity of 4.5%. Use $1000 as the face value.

d, What is the duration of a two-year zero-coupon (principal-only) bond that is yielding 6% and $10,000 face value? Note: This bond does not have coupon payments but does return the face value.

scarletreindeer413

All:

Everyone today has to be concerned about being able to retire comfortably when they keep telling us that Social Security will be bankrupt in 2037, a mere 22 years from now, and that it is an entitlement, not something that we and our employers all paid into since we got our first job.

A retirement planner is attached to this message so you can estimate how much money you will need to save to be able to do the things most retirees want to do when they are no longer working.

Then provide your calculations to the class and make a statement as to what you think and if you can achieve it?

For Week 3, please turn in the answers to the following questions:

1. Define the following terms as they apply to bonds:

a. Face value

b. Maturity date

c. Coupon interest (including coupon interest rate)

d. Current yield

e. Yield to maturity (YTM)

f. Yield to call (YTC)

g. Call premium

2. What are âZero-couponâ bonds?

3. Suppose you see the following bond price quote in the newspaper:

McDonalds 5.7% 2039â¦â¦..122.733

What can you tell about this bond from reading the price quote?

4. (calculating the present value of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a yield to maturity (YTM) of 4.201%, what should be its price in the bond market (ie, PV)?

5. (calculating the current yield of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a market price of $1,223.92, what is its current yield?

6. (calculating the YTM of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a market price of $1,223.92, what is its yield to maturity (YTM)?

7. (calculating the YTC of a bond) Assume a callable corporate bond with a face value of $1,000, a coupon interest rate of 5.7%, a market price of $1,223.92, and a call premium of 6%. Assume also that the bond has 24 years to go until it matures, but it is callable after 14 years. What is the bondâs yield to call (YTC)?

8. (calculating the present value of a bond with semi-annual coupon interest payments) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7%, paid semiannually, and has a yield to maturity (YTM) of 4.2%, what should be its price in the bond market (ie, PV)?

9. (calculating the YTM of a bond with semiannual interest payments) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7%, paid semiannually, and has a market price of $1,223.92, what is its yield to maturity (YTM)?

10. Define the following terms as they apply to interest rates:

a. The real risk-free rate (r*)

b. The nominal risk-free rate (Rrf)

c. The inflation premium (IP)

d. The default risk premium (DRP)

e. The liquidity premium (LP)

f. The maturity risk premium (MRP)

11. Assume the real risk-free rate is 1%. Assume also that inflation is expected to be 1% in the coming year (year 1), 2% in the next year after that (year 2), and 3% in the year after that (year 3). Assume also that the default risk premium, the liquidity premium, and the maturity risk premium are 0%. Given these conditions, what would be the yield on three-year treasury bonds today?

12. Suppose the First Bank of St Louis was offering the following rates on certificates of deposit (CDs) this week:

Maturity Rate

3 month 1.50%

6 month 1.75%

1 year 2.00%

2 year 2.25%

3 year 2.50%

5 year 2.75%

10 year 3.00%

20 year 3.15%

a. Plot the above data on a yield curve. Label the graph and the axes appropriately.

b. Comment on the implications of this curve to you, as a potential investor in CDs.

End of assignment questions

(see answers to numerical problems on the next page)

Answers to numerical problems:

Question 4: $1,223.92

Question 5: 4.66%

Question 6: 4.2%

Question 7: 3.92%

Question 8: $1,225.44

Question 9: 4.21%

Question 11: 3.0%

FNBU 3221 Lecture 10: Chapter 9

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