1、CHAPTER 7INTEREST RATES AND BOND VALUATIONCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-2 Define important bond features and types of bond Explain bond values and yields and why they fluctuate Des
2、cribe bond ratings and what they mean Outline the impact of inflation on interest rates Illustrate the term structure of interest rates and the determinants of bond yieldsKEY CONCEPTS AND SKILLSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior
3、 written consent of McGraw-Hill Education.7-3 Bonds and Bond Valuation More about Bond Features Bond Ratings Some Different Types of Bonds Bond Markets Inflation and Interest Rates Determinants of Bond YieldsCHAPTER OUTLINECopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or d
4、istribution without the prior written consent of McGraw-Hill Education.7-4 Par value(face value)=principal amount,repaid at maturity Coupon=stated interest payment Coupon rate=annual coupon divided by face value Maturity date Yield or Yield to maturity=rate of return required in the market for the b
5、ondBOND DEFINITIONSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-5 Bond Value=PV of coupons+PV of par Bond Value=PV of annuity+PV of lump sum As interest rates increase,present values decrease.So,
6、as interest rates increase,bond prices decrease and vice versa.PRESENT VALUE OF CASH FLOWS AS RATES CHANGECopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-6 Consider a bond with a coupon rate of 10%a
7、nd annual coupons.The par value is$1,000,and the bond has 5 years to maturity.The yield to maturity is 11%.What is the value of the bond?Using the formula:B=PV of annuity+PV of lump sum B=1001 1/(1.11)5/.11+1,000/(1.11)5 B=369.59+593.45=963.04 Using the calculator:N=5;I/Y=11;PMT=100;FV=1,000 CPT PV=
8、-963.04VALUING A DISCOUNT BOND WITH ANNUAL COUPONSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-7 Suppose you are reviewing a bond that has a 10%annual coupon and a face value of$1000.There are 20
9、 years to maturity,and the yield to maturity is 8%.What is the price of this bond?Using the formula:B=PV of annuity+PV of lump sum B=1001 1/(1.08)20/.08+1000/(1.08)20 B=981.81+214.55=1196.36 Using the calculator:N=20;I/Y=8;PMT=100;FV=1000 CPT PV=-1,196.36VALUING A PREMIUM BOND WITH ANNUAL COUPONSCop
10、yright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-8 6007008009001000110012001300140015000%2%4%6%8%10%12%14%GRAPHICAL RELATIONSHIP BETWEEN PRICE AND YIELD-TO-MATURITY(YTM)Yield-to-maturity(YTM)Bond charac
11、teristics:10 year maturity,8%coupon rate,$1,000 par valueYield-to-Maturity(YTM)Bond Price,in dollarsCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-9 If YTM=coupon rate,then par value=bond price If
12、YTM coupon rate,then par value bond price Why?The discount provides yield above coupon rate.Price below par value,called a discount bond If YTM coupon rate,then par value bond price Why?Higher coupon rate causes value above par.Price above par value,called a premium bondBOND PRICES:RELATIONSHIP BETW
13、EEN COUPON AND YIELDCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-10 THE BOND PRICING EQUATIONttr)(1FVrr)(11-1C Value BondCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction o
14、r distribution without the prior written consent of McGraw-Hill Education.7-11 If an ordinary bond has a coupon rate of 14 percent,then the owner will get a total of$140 per year,but this$140 will come in two payments of$70 each.The yield to maturity is quoted at 16 percent.The bond matures in seven
15、 years.Note:Bond yields are quoted like APRs;the quoted rate is equal to the actual rate per period multiplied by the number of periods.EXAMPLE 7.1Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-12
16、How many coupon payments are there?What is the semiannual coupon payment?What is the semiannual yield?What is the bond price?B=701 1/(1.08)14/.08+1,000/(1.08)14=917.56 Or PMT=70;N=14;I/Y=8;FV=1,000;CPT PV=-917.56EXAMPLE 7.1(CTD.)Copyright 2019 McGraw-Hill Education.All rights reserved.No reproductio
17、n or distribution without the prior written consent of McGraw-Hill Education.7-13 Price Risk Change in price due to changes in interest rates Long-term bonds have more price risk than short-term bonds.Low coupon rate bonds have more price risk than high coupon rate bonds.Reinvestment Rate Risk Uncer
18、tainty concerning rates at which cash flows can be reinvested Short-term bonds have more reinvestment rate risk than long-term bonds.High coupon rate bonds have more reinvestment rate risk than low coupon rate bonds.INTEREST RATE RISKCopyright 2019 McGraw-Hill Education.All rights reserved.No reprod
19、uction or distribution without the prior written consent of McGraw-Hill Education.7-14 FIGURE 7.2Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-15 Yield to Maturity(YTM)is the rate implied by the c
20、urrent bond price.Finding the YTM requires trial and error if you do not have a financial calculator and is similar to the process for finding r with an annuity.If you have a financial calculator,enter N,PV,PMT,and FV,remembering the sign convention(PMT and FV need to have the same sign,PV the oppos
21、ite sign.)COMPUTING YIELD TO MATURITYCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-16 Consider a bond with a 10%annual coupon rate,15 years to maturity,and a par value of$1,000.The current price i
22、s$928.09.Will the yield be more or less than 10%?N=15;PV=-928.09;FV=1,000;PMT=100;CPT I/Y=11%YTM WITH ANNUAL COUPONSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-17 Suppose a bond with a 10%coupon
23、 rate and semiannual coupons,has a face value of$1,000,20 years to maturity and is selling for$1,197.93.Is the YTM more or less than 10%?What is the semiannual coupon payment?How many periods are there?N=40;PV=-1,197.93;PMT=50;FV=1,000;CPT I/Y=4%(Is this the YTM?)YTM=4%2=8%YTM WITH SEMIANNUAL COUPON
24、SCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-18 TABLE 7.1Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill
25、 Education.7-19 Current Yield=annual coupon/price Yield to maturity=current yield+capital gains yield Example:10%coupon bond,with semiannual coupons,face value of 1,000,20 years to maturity,$1,197.93 price Current yield=100/1,197.93=.0835=8.35%Price in one year,assuming no change in YTM=1,193.68 Cap
26、ital gain yield=(1,193.68 1,197.93)/1,197.93=-.0035=-.35%YTM=8.35-.35=8%,which is the same YTM computed earlierCURRENT YIELD VS.YIELD TO MATURITYCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-20 Bo
27、nds of similar risk(and maturity)will be priced to yield about the same return,regardless of the coupon rate.If you know the price of one bond,you can estimate its YTM and use that to find the price of the second bond.This is a useful concept that can be transferred to valuing assets other than bond
28、s.BOND PRICING THEOREMSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-21 There is a specific formula for finding bond prices on a spreadsheet.PRICE(Settlement,Maturity,Rate,Yld,Redemption,Frequency
29、,Basis)YIELD(Settlement,Maturity,Rate,Pr,Redemption,Frequency,Basis)Settlement and maturity need to be actual dates.The redemption and Pr need to be input as%of par value.Click on the Excel icon for an example.BOND PRICES WITH A SPREADSHEETCopyright 2019 McGraw-Hill Education.All rights reserved.No
30、reproduction or distribution without the prior written consent of McGraw-Hill Education.7-22 Debt Not an ownership interest Creditors do not have voting rights Interest is considered a cost of doing business and is tax deductible Creditors have legal recourse if interest or principal payments are mi
31、ssed Excess debt can lead to financial distress and bankruptcy Equity Ownership interest Common stockholders vote for the board of directors and other issues Dividends are not considered a cost of doing business and are not tax deductible Dividends are not a liability of the firm,and stockholders ha
32、ve no legal recourse if dividends are not paid An all equity firm can not go bankrupt merely due to debt since it has no debtDIFFERENCES BETWEEN DEBT AND EQUITYCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Ed
33、ucation.7-23 Contract between the company and the bondholders that includes:The basic terms of the bonds The total amount of bonds issued A description of property used as security,if applicable Sinking fund provisions Call provisions Details of protective covenantsTHE BOND INDENTURECopyright 2019 M
34、cGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-24 Registered vs.Bearer Forms Security Collateral secured by financial securities Mortgage secured by real property,normally land or buildings Debentures unsecured No
35、tes unsecured debt with original maturity less than 10 years SeniorityBOND CLASSIFICATIONSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-25 The coupon rate depends on the risk characteristics of th
36、e bond when issued.Which bonds will have the higher coupon,all else equal?Secured debt versus a debenture Subordinated debenture versus senior debt A bond with a sinking fund versus one without A callable bond versus a non-callable bondBOND CHARACTERISTICS AND REQUIRED RETURNSCopyright 2019 McGraw-H
37、ill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-26 High Grade Moodys Aaa and S&P AAA capacity to pay is extremely strong Moodys Aa and S&P AA capacity to pay is very strong Medium Grade Moodys A and S&P A capacity to pay
38、is strong,but more susceptible to changes in circumstances Moodys Baa and S&P BBB capacity to pay is adequate,adverse conditions will have more impact on the firms ability to payBOND RATINGS INVESTMENT QUALITYCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution wi
39、thout the prior written consent of McGraw-Hill Education.7-27 Low Grade Moodys Ba and B S&P BB and B Considered possible that the capacity to pay will degenerate.Very Low Grade Moodys C(and below)and S&P C(and below)income bonds with no interest being paid,or in default with principal and interest i
40、n arrearsBOND RATINGS SPECULATIVE GRADECopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-28 Treasury Securities Federal government debt T-bills pure discount bonds with original maturity of one year o
41、r less T-notes coupon debt with original maturity between one and ten years T-bonds coupon debt with original maturity greater than ten years Municipal Securities Debt of state and local governments Varying degrees of default risk,rated similar to corporate debt Interest received is tax-exempt at th
42、e federal level.GOVERNMENT BONDSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-29 A taxable bond has a yield of 8%,and a municipal bond has a yield of 6%.If you are in a 30%tax bracket,which bond d
43、o you prefer?8%(1-.3)=5.6%The after-tax return on the corporate bond is 5.6%,compared to a 6%return on the municipal At what tax rate would you be indifferent between the two bonds?8%(1 T)=6%T=25%EXAMPLE 7.4Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution with
44、out the prior written consent of McGraw-Hill Education.7-30 Make no periodic interest payments(coupon rate=0%)The entire yield-to-maturity comes from the difference between the purchase price and the par value.Cannot sell for more than par value Sometimes called zeroes,deep discount bonds,or origina
45、l issue discount bonds(OIDs)Treasury Bills and principal-only Treasury strips are good examples of zeroes.ZERO COUPON BONDSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-31 Coupon rate floats depen
46、ding on some index value Examples adjustable rate mortgages and inflation-linked Treasuries There is less price risk with floating rate bonds.The coupon floats,so it is less likely to differ substantially from the yield-to-maturity.Coupons may have a“collar”the rate cannot go above a specified“ceili
47、ng”or below a specified“floor”.FLOATING-RATE BONDSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-32 Catastrophe bonds Income bonds Convertible bonds Put bonds There are many other types of provisio
48、ns that can be added to a bond and many bonds have several provisions it is important to recognize how these provisions affect required returnsOTHER BOND TYPESCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Edu
49、cation.7-33 Sukuk are bonds that have been created to meet a demand for assets that comply with Shariah,or Islamic law.Shariah does not permit the charging or paying of interest.Sukuk are typically bought and held to maturity,and they are extremely illiquid.SUKUKCopyright 2019 McGraw-Hill Education.
50、All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.7-34 Primarily over-the-counter transactions with dealers connected electronically Extremely large number of bond issues,but generally low daily volume in single issues Makes getting up-to-
