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BOND ANALYSIS AND

BOND VALUATION

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INTRODUCTION:

Abondis a security that is issued in connection with a borrowingarrangement. The borrower issues (i.e., sells) a bond to the lender forsome amount of cash; the bond is in essence the IOU of the borrower.The arrangement obligates the issuer to make specified payments tothe bondholder on specified dates. A typical coupon bond obligates theissuer to make semiannual payments of interest, called couponpayments, to the bondholder for the life of the bond.

Face Value:face value, par value The payment to the bondholder at thematurity of the bond.Coupon Rate:Coupon Rate A bonds annual interest payment per dollar ofpar value.

To illustrate, a bond with a par value of $1,000 and a coupon rate of8% might be sold to a buyer for $1,000. The issuer then pays thebondholder 8% of $1,000, or $80 per year, for the stated life of thebond, say, 30 years. The $80 payment typically comes in twosemiannual installments of $40 each. At the end of the 30-year life ofthe bond, the issuer also pays the $1,000 par value to the bondholder.

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TYPES OF BOND:Zero-coupon Bond:A bond paying no coupons that sells at a discount andprovides only a payment of par value at maturity

Callable Bonds:A bond that may be repurchased by the issuer at aspecified call price during the call period.

Convertible Bonds:A bond with an option allowing the bondholder toexchange the bond for a specified number of shares of common stock in the firm.

Put Bond:A bond that the holder may choose either to exchange for par

value at some date or to extend for a given number of years.Floating-rate Bonds:A bond with coupon rates periodically reset accordingto a specified market rate.

Inflation Adjusted Treasury Bond:A bond whose coupon rate changeswith inflation.

Deferred Coupon Bonds: Carry Coupons, but initial coupon payment isdeferred for some period.

Investment Grade Bond:A bond rated BBB and above by Standard &Poors, or Baa and above by Moodys.

Junk Bond:A bond rated BB or lower by Standard & Poors, or Ba or lowerby Moodys, or an unrated bond.

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RISK OF INVESTING IN BOND:

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RETURN ON BOND:

BOND PRICING:

The nominal risk-free interest rate equals the sum of (1) a real risk-free rate of return and (2) a premium above the real rate to

compensate for expected inflation. In addition, because most bondsare not riskless, the discount rate will embody an additional premiumthat reflects bond-specific characteristics such as default risk,liquidity risk, maturity risk, tax attributes, call risk, and so on.

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Premium bonds: price > par value, YTM < coupon rateDiscount bonds: price < par value, YTM > coupon ratePar bonds: price = par value, YTM = coupon rate

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BOND PRICING:Price Formula:

Yield to Maturity:

Current Yield:

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BOND RETURN:

on as a coupon ra e o n eres ra es are e pec e o

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on as a coupon ra e o . n eres ra es are expec e odecrease due to a newly instituted economic package. What will happento the price of this bond? Why?

ow much should you pay for a !1"000 bond with 10% coupon" annualpayments" and #$e years to maturity if the interest rate is 1%?A& ! '(.'0 )& ! '*1.+0 ,& !1"000.00 -& !1"0(.*

) What is the coupon rate for a bond with three years until maturity" aprice of !1"0/.+" and a yield to maturity of %?A& % )& *% ,& 10% -& 11%

) What is the yield to maturity A23& of a bond with the followingcharacteristics? ,oupon rate is *% with semi4annual payments" currentprice is !'0" three years until maturity.A& +.(*% )& .+*% ,& '.*(% -& 1.1(%

) What is the rate of return for an in$estor who pays !1"0+.+( for athree4year bond with a (% coupon and sells the bond one year later for!1"0/(.1'?A& .00% )& .//% ,& .+% -& (.00%

) A two4year bond with par $alue !1"000 making annual coupon

payments of !100 is priced at !1"000. What is the yield to maturity of thebond? What will be the reali5ed compound yield to maturity if the one4

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Effective Duration

An interpretation of duration is the approximate percentage change in

price for a 1% change in yield. This interpretation, price sensitivity inresponse in response to a change in yield.

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