Business Finance - Chapter 6 .pptx

8/11/2019 Business Finance - Chapter 6 .pptx

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6-1


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6-2

Key Concepts and Skills

Know the important bond features andbond types

Understand:

Bond values and why they fluctuate

Bond ratings and what they mean

The impact of inflation on interest rates

The term structure of interest rates andthe shape of the yield curve

determinants of bond yields


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Chapter Outline

6.1 Bonds and Bond Valuation

6.2 More on Bond Features

6.3 Bond Ratings6.4 Some Different Types of Bonds

6.5 Bond Markets

6.6 Inflation and Interest Rates6.7 Determinants of Bond Yields


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Bond Definitions

Bond

Debt contract

Normally a interest-only loan

Par value (face value) ~ $1,000 (repaid at end)

Coupon payment =(interest payment on bond)

Coupon rate =(annual coupon / face value) Maturity date =(time until face value repaid)

Yield to maturity= (market interest rate required on bond)


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Key Features of a Bond

Par value: Face amount

Re-paid at maturity

Assume $1,000 for corporate bonds

Coupon interest rate: Stated interest rate

Usually = YTM at issue YTM = Yield to Maturity

Multiply by par value to get coupon payment


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Bond Calculations

6-6

Coupon Payment = Coupon Rate Par Value

Coupon Rate = Coupon Payment / Par Value

Par Value = Coupon Payment / Coupon Rate

CP = CR * PRV

CR =

PRV =


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Key Features of a Bond

Maturity:

Years until bond must be repaid

Yield to maturity (YTM):

The market required rate of return for bonds of

similarriskand maturity

The discount rate used to value a bond

Return if bond held to maturity

Usually = coupon rate at issue

Quoted as an APR


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Bond Value

Bond Value = PV(coupons) + PV(par)

Bond Value = PV(annuity) + PV(lump sum)

Remember:As interest rates increase present values

decrease ( r PV )

As interest rates increase, bond pricesdecrease and vice versa


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The Bond-Pricing Equation

t

t

YTM)(1

F

YTM

YTM)(1

1

1-CValueBond

PV(Annuity) PV(lump sum)

C = Coupon payment; F = Face value

Return

to Quiz

What is the relationship between bond prices and yields?


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Spreadsheet Formulas

=FV(Rate,Nper,Pmt,PV,0/1)

=PV(Rate,Nper,Pmt,FV,0/1)

=RATE(Nper,Pmt,PV,FV,0/1)

=NPER(Rate,Pmt,PV,FV,0/1)

=PMT(Rate,Nper,PV,FV,0/1)

Inside parens: (RATE,NPER,PMT,PV,FV,0/1) 0/1Ordinary annuity = 0 (default)

Annuity Due = 1 (must be entered)


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Pricing Specific Bonds in Excel=PRICE(Settlement,Maturity,Rate,Yld,Redemption,

Frequency,Basis)=YIELD(Settlement,Maturity,Rate,Pr,Redemption,

Frequency,Basis)

Settlement = actual date as a serial number; date

settled after security issued. Maturity = actual date as a serial number; maturity date

of bond.

Redemption and Pr(ice) = % of par value

Rate (coupon) and Yld = annual rates as decimals Frequency = # of coupons per year

Basis = day count convention (enter 2 for ACT/360)


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Basis: Type of day count basis to use.

6-12


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Bond Cash Flows

6-13

What is the present value of the face (par) value?

What is the present value of the annual coupon payments?

What is the total bond value?

Using Excel: =PV(0.08, 10, 80, 0, 0) = 536.81

Using Excel: =PV(0.08, 10, 0, 1000, 0) = 463.19

TV = PV Par + PV Coupons = 463.19 + 536.81 = 1,000


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6-14

NOTE: Coupon Rate andMarket Rate are Equal


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6-15

The amount lost due to rising rates.


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6-16

The amount gained due to falling rates.


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6-17

Valuing a New Bond with AnnualCoupons Issued at Market

Coupon rate = 10% Annual coupons

Par = $1,000

Maturity = 5 years

YTM = 10%

5

5

101

1000

100

101

11

100

).(.

).(

B

Using the formula:B = PV(annuity) + PV(lump sum)

B = 379.08 + 620.92 = 1000

Using Excel: =PV(0.10, 5, 100, 1000, 0) = $1000

Note: When YTM = Coupon rate Price = Par Value


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6-18

Valuing a Discount Bond withAnnual Coupons

Coupon rate = 10% Annual coupons

Par = $1,000

Maturity = 5 years

YTM = 11%

5

5

)11.1(

1000

11.0

)11.1(

11

100B


B = 369.59 + 593.45 = 963.04

Note: When YTM > Coupon rate Price < Par = Discount Bond

Using Excel: =PV(0.11, 5, 100, 1000, 0) = $963.04


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6-19

Valuing a Premium Bond withAnnual Coupons

Coupon rate = 10%

Annual coupons

Par = $1,000

Maturity = 20 years YTM = 8%

20

20

)08.1(

1000

08.0

)08.1(

11

100

B


B = 981.81 + 214.55 = 1196.36

Note: When YTM < Coupon rate Price > Par = Premium Bond

Using Excel: =PV(0.08, 20, 100, 1000, 0) = $1,196.36


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6-20

Graphical Relationship Between Priceand Yield-to-maturity

600

700

800

900

1000

1100

1200

1300

1400

1500

0% 2% 4% 6% 8% 10% 12% 14%

Bond

Pr

ice

Yield-to-maturity

What is par value of the bond and what is the coupon rate?


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Bond Prices:Relationship Between Coupon and Yield

Coupon rate = YTM Price = Par

Coupon rate < YTM Price < Par

Discount bond Why? Because the bond pays less than the market rate of interest.

Coupon rate > YTM Price > Par

Premium bond Why? Because the bond pays more than the market rate of interest.


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6-22

M

Premium

1,000

Discount

30 25 20 15 10 5 0

CR>YTM

CR


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6-23

The Bond-Pricing EquationAdjusted for Semi-annualCoupons

2t

2t

YTM/2)(1

F

YTM/2

YTM/2)(1

1-1

2

CValueBond

C = Annual coupon payment C/2 = Semi-annual coupon

YTM = Annual YTM (as an APR) YTM/2 = Semi-annualYTM

t = Years to maturity 2t = Number of 6-monthperiods to maturity


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Semiannual BondsExample 6.1

Coupon rate = 14% - Semiannual

YTM = 16% (APR)

Maturity = 7 years Number of coupon payments? (t)

14 = 2 x 7 years

Semiannual coupon payment? (C)

$70 = (14% x Face Value)/2 Semiannual yield? (YTM)

8% = 16%/2


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Example 6.1

Semiannual coupon = $70

Semiannual YTM = 8%

Periods to maturity = 14

Bond value =

70[11/(1.08)14] / .08 +1000 / (1.08)14= 917.56

t

t

YTM)(1F

YTMYTM)(1

11-

CValueBond

14

14

)08.1(1000

08.0)08.1(

11

70

B

Using Excel: =PV(0.08, 14, 70, 1000, 0)


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Bond Prices: 3

2-26

Using Excel: =PV(0.08, 9, 60, 1000, 0) = $875.06

Using Excel: =10*PRICE(settlement,maturity,0.06,0.08,100,1) = $875.06
http://localhost/var/www/apps/conversion/tmp/scratch_1/EOC_8th_edition_Chapter_06.xlsxhttp://localhost/var/www/apps/conversion/tmp/scratch_1/EOC_8th_edition_Chapter_06.xlsx


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Bond Yields: 4

2-27

Using Excel: =RATE(9,70,-1038.5,1000,0) = 6.42%

Using Excel: =YIELD(settlement,maturity,0.7,103.85,100,1) = 6.42%


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Coupon Rates: 5

2-28

Using Excel: =PMT(0.075,12,-963,1000,0) = $70.22

7.022%.,

. 070220

0001

2270

PRV

CPCR

Using Excel: =RATE(12,70.22,-963,1000,0) = 7.50%


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Interest Rate Risk

Price Risk

Change in price due to changes in interestrates

Long-term bonds have more price risk thanshort-term bonds

Low coupon rate bonds have more pricerisk than high coupon rate bonds

Bonds with a higher coupon has a larger cash flow early in its life,

so its value is less sensitive to changes in the discount rate.


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Interest Rate Risk

Reinvestment Rate Risk Uncertainty concerning rates at which cash

flows coupons can be reinvested at same rate

Short-term bonds have more reinvestment raterisk than long-term bonds

High coupon rate bonds have morereinvestment rate risk than low coupon rate

bonds


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Figure 6.2

The longer the time to maturity, the greater

the interest rate risk; ceteris paribus. Smallchanges in interest rates can lead to largechanges in the bonds value.


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Computing Yield-to-Maturity YTM

Yield-to-maturity (YTM) = the marketrequired rate of return implied by thecurrent bond price

With a financial calculator or Excel,

Enter ,/,.and0

Remember the sign convention

/

and0

need to have the same sign (+)

.the opposite sign (-)


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YTM with Annual Coupons

Consider a bond with a 10% annualcoupon rate, 15 years to maturity and apar value of $1000. The current price is$928.09. Will the yield be more or less than 10%?

Using Excel: =RATE(15, 100, -928.09, 1000, 0) = 11% = YTM


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YTM with Semiannual Coupons

Suppose a bond with a 10% coupon rateand semiannual coupons, has a face value

of $1000, 20 years to maturity and is

selling for $1,197.93. Is the YTM more or less than 10%?

The bond is trading at a premium, YTM < CR

What is the semiannual coupon payment? CP = 10% * $1,000 = $100 / 2 = $50

How many periods are there?

T*2 = 20 * 2 = 40


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YTM with Semiannual Coupons

Suppose a bond with a 10% coupon rate andsemiannual coupons, has a face value of $1,000,20 years to maturity and is selling for $1,197.93.

NOTE: Solving a semi-annual payer

for YTM results in a 6-month YTM.

Excel will solve what you enter.

Using Excel: =RATE(40, 50, -1197.93, 1000, 0) = 4%4% or YTM * 2 = 8% YTM

Using Excel: =RATE(40, 50, -1197.93, 1000, 0)*2 = 8%


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Table 6.1


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Debt versus Equity

Debt Notan ownership interest No voting rights

Interest is tax-deductible(issuer, sometimes by holder)

Creditors have legal recourseif interest or principalpayments are missed

Debt can result in higherreturns to the firm (taxbenefits to debt), but

Excess debt can lead tofinancial distress andbankruptcy

Equity Ownership interest

Common stockholdersvote to elect the board ofdirectors and on otherissues

Dividends are not taxdeductible (by firm orstockholder)

Dividends are not aliability of the firm untildeclared. Stockholders

have no legal recourse ifdividends are not declared

Equity holders are paidafter debt holders, but notrequired

An all-equity firm cannotgo bankrupt


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The Bond IndentureDeed of Trust

Contract between issuing company andbondholders includes:

Basic terms of the bonds

Total amount of bonds issued Secured versus Unsecured

Sinking fund provisions

Call provisions Deferred call

Call premium

Details of protective covenantsReturn

to Quiz


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Bond Classifications

Registered vs. Bearer Bonds Registered: company records ownership, payments made to

and information sent to owner.

Bearer: Issued without record of owner name, payments madeto holder after receipt of detachable coupon. May be difficult torecover if lost or stolen, bondholders cannot be notified ofimportant event.

Security Collateral: secured by financial securities (bonds and stocks)

Mortgage: secured by real property, normally land or buildings

Debentures: unsecured

Notes: unsecured debt with original maturity less than 10 years


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Seniority Senior versus Junior, Subordinated

Debt cannot be subordinated to equity.

Repayment Can be repaid at maturity, or sinking fund

established to retire or repurchase bonds

Call Provision

Repurchase or call part or all of bond issueat a specific price prior to maturity, usually ata premium, the call may be deferred and thebondholder protected during the prohibition

period.


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Protective Covenants Indenture provision that limit certain actions

that might be taken during the term of theloan, usually to protect the lender.

Negative Covenants: Thou Shalt Not Limit amount of dividends to prescribed formula

No pledging of any assets to other lenders

No merger with another firm

No issuance of additional long-term debt Positive Covenants: Thou Shalt

Maintain working capital at or above a certain level

Furnish financial statements to lender

Maintain collateral in good condition

B d Ch t i ti d


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Bond Characteristics andRequired Returns

Coupon rate

(risk characteristics of the bond when issued)

Usually yield at issue

Which bonds will have the higher coupon,all else equal? Secured debt versus a debenture

Subordinated debenture versus senior debtA bond with a sinking fund versus one without

Sinking funds can retire a portion of the debt or call some bonds

A callable bond versus a non-callable bond


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Bond Ratings

Bond ratings are concerned onlywith thepossibility of default.

Bond ratings do not address interest rate risk,

the risk of a change in the value (i.e. price) of abond resulting from a change in interest rates.

The price of a highly rated bond can still be quitevolatile given interest rate risk.

Return

to Quiz


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Investment-grade bonds are bonds rated at least BBB by S&P or Baa byMoodys.

A bonds credit rating can change as the issuers financial strength improves

or deteriorates. Credit ratings are important because defaults really do occur, and if they do,

investors can lose heavily.


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Bond RatingsInvestment Quality

High Grade MoodysAaa and S&P AAAcapacity to pay is

extremely strong

MoodysAa and S&P AAcapacity to pay is verystrong

Medium Grade

Moodys A and S&P A capacity to pay is strong,

but more susceptible to changes in circumstances Moodys Baa and S&P BBB capacity to pay is

adequate, adverse conditions will have moreimpact on the firms ability to pay

Return

to Quiz


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Bond Ratings - Speculative

Low Grade Moodys Ba, B, Caa and Ca

S&P BB, B, CCC, CC

Considered speculative with respect to capacityto pay. The B ratings are the lowest degree

of speculation.

Very Low Grade

Moodys C and S&P C income bonds with nointerest being paid

Moodys D and S&P D in default withprincipal and interest in arrears


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Government Bonds

Treasury Securities = Federal government debt Treasury Bills (T-bills)

Pure discount bonds

Original maturity of one year or less

Treasury notes Coupon debt

Original maturity between one and ten years

Treasury bonds Coupon debt Original maturity greaterthan ten years

Exempt from state but not federal taxation.

G t B d


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Government Bonds

Municipal Securities Debt of state and local governments

Varying degrees of default risk, rated similar to

corporate debt Interest received is tax-exempt at the federal

level

Interest usually exempt from state tax in

issuing state

Yields usually lower than treasury or corporatebonds since advantage of not being taxed.

Example 6 4


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Example 6.4

A taxable bond has a yield of 8% and a

municipal bond has a yield of 6% If you are in a 40% tax bracket, which bond do you prefer?

What is the after tax return on a taxable bond?

8%(1 - .4) = 4.8%

The after-tax return on the corporate bond is 4.8%, compared to a 6%return on the municipal

At what tax rate would you be indifferent between the twobonds?

8%(1T) = 6%

T = 25%

At what municipal yield would you be indifferent to a taxablebond?

8%(1-0.40)=M

M=4.8


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Zero Coupon Bonds

Make no periodic interest payments (coupon rate = 0%)

Entire yield-to-maturity comes from the differencebetween the purchase price and the par value (capital

gains) Cannot sell for more than par value

Sometimes called zeroes, or deep discount bonds

Treasury Bills and U.S. Savings bonds are goodexamples of zeroes

Z C B d I t t


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Zero Coupon Bond Interest

EIN Company issues a $1,000 face value, five-year zero

coupon bond. What should the bond sell for at issue, assuminga 14 percent yield to maturity using semiannual periods?

6-54

Using Excel: =PV(0.07, 10, 0, 1000, 0) = $508.35

What is the amount of interest paid over the life of the bond?

$1000 - $508.35 = $491.65

What is the annual interest deduction calculated on a

straight-line basis?

$491.65 / 5 = $98.33

NOTE: The issuer of a zero must deduct interest every year even though no interest is actually paid. Also,the owner must pay taxes on interest accrued every year even though no interest is received. Current tax

law requires interest to be determined by amortizing the loan as opposed to straight line.

Z C I li it B d I t t


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Zero Coupon Implicit Bond Interest

6-55

Floating Rate Bonds


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Floating Rate Bonds

Coupon rate floats depending on some indexvalue

Examplesadjustable rate mortgages andinflation-linked Treasuries (TIPS)

Less price risk with floating rate bonds Coupon floats, so is less likely to differ

substantially from the yield-to-maturity

Coupons may have a collar the ratecannot go above a specified ceiling orbelow a specified floor

Other Bond Types


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Other Bond Types

Income bonds Coupon dependent on company income

Convertible bonds Convertible to shares of stock

Put bonds Holder forces issues to buy back at stated price, the

reverse of a call provision

Many types of provisions can be added to a bond Important to recognize how these provisions affect

required returns

Who does the provision benefit?

B d M k


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Bond Markets

Primarily over-the-counter transactions withdealers connected electronically

Extremely large number of bond issues(compared to equity), but generally low daily

volume in single issues and little transparency Getting up-to-date prices difficult, particularly

on small company or municipal issues

Treasury securities are an exception What is the largest securities market in the

world?

U.S. Treasury Market not the NYSE.


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Work the Web Example

Bond information is available online One good site:

http://cxa.marketwatch.com/finra/BondCenter

Click on the web surfer to go to the site Use Quick Bond Search to observe the

yields for various bond types, and theshape of the yield curve.
http://cxa.marketwatch.com/finra/BondCenterhttp://cxa.marketwatch.com/finra/BondCenterhttp://cxa.marketwatch.com/finra/BondCenter


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Bond Yields: 7

2-61

Using Excel: =RATE(26, 34.50, -940, 1000, 0) = 3.82%

3.82% or YTM * 2 = 7.64% YTMUsing Excel: =2*RATE(21, 34.50, -945, 1000, 0) = 7.64%


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Coupon Rates: 8

2-62

Using Excel: =PMT(0.042, 21, -945, 1000, 0) = $38.01

$38.01*2 = $76.02; $76.02 / $1,000 = 7.60%


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Bond Yields: 19

2-63

Using Excel: =2*RATE(40, 39, -1125, 1000, 0) = 6.66%

Treasury Quotations


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Treasury Quotations

Treasury Quotations


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Treasury Quotations Highlighted quote in Figure 6.3

5/15/2030 6.250 150.7188 150.7500 .8906 2.713

When does the bond mature?

What is the coupon rate on the bond?

What is the bid price? What does this mean?

May 15, 2030

6.25% per year on semiannual basis, $62.50/2 = $31.25 on a $1,000face value bond

Bidamount dealer offers to buy from you, 150.7188% (i.e.,1.507188) of the par or face value, therefore the bid is $1,570.188 =(1, 000 * 1.507188)

Treasury Quotations


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5/15/2030 6.250 150.7188 150.7500 .8906 2.713

What is the ask price? What does this mean?

How much did the price change from the previous day?

What is the YTM based on Ask price and why?

Askamount dealer is willing to sell to you, 150.7500% of the par orface value (i.e., 1.507500), therefore the ask is = $1,507.50 = ($1,000* 1.507500)

Asked price up by 0.890% from the previous day

Asked yield is 2.713%, lower than coupon rate since this is a premium

bond and sells for more than the face value.

Treasury Quotations


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5/15/2030 6.250 150.7188 150.7500 .8906 2.713

What is bid-ask spread, what does this represent?AskBid = $1,507.500 - $1,507.188 - = $0.312 and represents thedealers profit.

Q t d P i I i P i


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Quoted Price vs. Invoice Price

Quoted bond prices = clean price

Net of accrued interest

Invoice Price = dirty or full price

Price actually paid

Includes accrued interest

Accrued Interest

Interest earned since last coupon payment isowed to bond seller at time of sale

The Bellwether Bond


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The very lastbond, usuallyquoted on theevening news as

to the direction oflong-term interestrates. If bondyield went up(down), bondprice went down(up). This isknown as thebellwether bond.

I fl ti d I t t R t


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Inflation and Interest Rates

Real rate of interest=Change in purchasing power

Nominal rate of interest

= Quoted rate of interest,= Change in purchasing power and inflation

The ex ante nominal rate of interest

includes our desired real rate of returnplus an adjustment for expected inflation

The Fisher Effect


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The Fisher EffectThe Fisher Effect defines the relationship between real rates, nominal rates

and inflation

(1 + R) = (1 + r)(1 + h)

R= nominal rate (Quoted rate)

r= real rate

h= expectedinflation rate

R = r + h + rh= real + inflation + compounding

Approximation: R = r + h

only if r or h not high Return

to Quiz

rhhrR

rhhrR

rhhrR

hrR

11

11

111 ))(()(

The Fisher Effect


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6-72


and inflation

(1 + R) = (1 + r)(1 + h)


r= real rate


Return

to Quiz

h

hRr

hrhR

rhrhR

rhhrR

rhhrR

rhhrR

hrR

1

1

11

11

111

)(

))(()(

11

1

1

11

111

h

Rr

h

Rr

hrR ))(()(

The Fisher Effect


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6-73


and inflation

(1 + R) = (1 + r)(1 + h)


r= real rate


Return

to Quiz

r

rRh

rRrh

rRrhh

rhhrR

rhhrR

rhhrR

hrR

1

1

11

11

111

)(

))(()(

11

1

1

11

111

r

R

h

r

Rh

hrR ))(()(

Calculating The Fisher Effect


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6-74

Calculating The Fisher Effect

If the nominal interest rate is 15.50% and theinflation rate is 5%, what is the real rate?

(1 + R) = (1 + r)(1 + h)

(1 + 0.1550) = (1+ r)(1 + 0.05)

(1 + r) = 1.1550 / 1.05 = 1.10

r = 1.101 = 0.10 or 10%

Returnto Quiz100

051

1050

0501

0501550

1

.

.

.

.

..

r

r

h

hRr

1001101

10501

15501

11

1

..

.

.

r

r

h

Rr

Example 6 6


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6-75

Example 6.6

If we require a 10% real return and weexpect inflation to be 8%, what is the

nominal rate?

R = (1.1)(1.08)1 = .188 = 18.8%

Approximation: R = 10% + 8% = 18%

Because the real return and expected inflation are

relatively high, there is significant difference between

the actual Fisher Effect and the approximation.

C l l ti R l R t f R t 9


76/93

Calculating Real Rates of Return: 9

2-76

%..

..

.

).(

).(

)(

)(

)(

)()(

))((

))(()(

46202460

10246110161

0411101601

04101

11

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1

11

111

111

r

r

h

Rr

h

Rr

hrR

hrR

%..

.

.

.

..

)(

))((

))(()(

46202460

0161

0250

01601

01600410

1

1

11

111

111

r

r

h

hRr

hRhr

hRrhr

rhhrR

rhhrR

hrR

hrR

%..

..

.

.

.

.)(.

).)(().(

))(()(

46202460

10246110161

0411

0161

0411

1

016110411

01601104101

111

r

r

r

r

r

hrR

%..

..

:ionApproximat

520250

01600410

r

r

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Inflation and Nominal Ret rns 10
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Inflation and Nominal Returns: 10

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Nominal and Real Returns: 11

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6-79


Term structure: The relationship betweentime to maturity and yields, all else equal(Ceteris Paribus):

The effect of default risk, different coupons,etc. has been removed.

Shape of term structure determined by:

Real Rate of Interest

Inflation Premium Interest Rate Risk Premium

Increases with maturity length

Returnto Quiz



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6-80


Yield cu rve: Graphical representation ofthe term structure

Normal = upward-sloping L/T > S/T

Inverted = downward-sloping L/T < S/T

Returnto Quiz

Figure 6.5 A Upward-Sloping


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6-81

Figure 6.5 A Upward SlopingYield Curve

RISING

CONSTANT

RISING

Inflation Premium higher in long than short run.

Figure 6.5 B Downward-


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6-82

Figure 6.5 B DownwardSloping Yield Curve

FALLING

CONSTANT

RISING

Inflation Premium higher in short than long run.

Figure 6 6 Treasury Yield Curve


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6-83

Figure 6.6Treasury Yield Curve

Based on datain Figure 6.3
http://www.bloomberg.com/markets


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6-84

Factors Affecting Required Return


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6-85

Factors Affecting Required Return

Default risk premiumbond ratings

Taxability premiummunicipal versus taxable

Liquidity premiumbonds that have more

frequent trading will generally have lowerrequired returns

Maturity premiumlonger term bonds will tendto have higher required returns.

Anything else that affects the r isk o f the cash f lows to

the bondho lders w i l l affect the required returns

Returnto Quiz

Interest Rate Risk: 17


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Interest Rate Risk: 17

2-86

Using Excel: =PV(0.04, 20, 20, 1000, 0) = $728.19

Using Excel: =PV(0.05, 20, 20, 1000, 0) = $626.13

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Using Excel: =PV(0.05, 20, 70, 1000, 0) = $1,249.24

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The lower the coupon rate,the greater the price

sensitivity of the bond tochanges in interest rates.

Quick Quiz


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6-87

Quick Quiz How do you find the value of a bond and why

do bond prices change? (Slide 6.8) What is a bond indenture and what are someof the important features? (Slide 6.30)

What are bond ratings and why are they

important?(Slide 6.33)

How does inflation affect interest rates?(Slide 6.48)

What is the term structure of interest rates?(Slide 6.50)

What factors determine the required return onbonds? (Slide 6.54)

E d f Ch t Q ti t R i


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End of Chapter Questions to Review

Question Topic

1 Interpreting Bond Yields

2 Interpreting Bond Yields

3 Bond Prices

4 Bond Yields5 Coupon Rates

6 Bond Prices

7 Bond Yields

8 Coupon Rates

9 Calculating Real Rates of Return

10 Inflation and Nominal Returns

11 Nominal and Real Returns

5-88

E d f Ch t Q ti t R i


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End of Chapter Questions to Review

Question Topic

12 Nominal versus Real Returns

13 Using Treasury Quotes

17 Interest Rate Risk

18 Bond Yields19 Bond Yields

5-89


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6-90

Chapter 6

END

Previous Treasury Quotations


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6-91

y Highlighted quote in Figure 6.3

2020 Feb 15 8.5 145.12 145.15 +64 3.4730

When does the bond mature?

What is the coupon rate on the bond?

What is the bid price? What does this mean?

February 15, 2020

8.5% per year on semiannual basis, $85/2 = $42.50 on a $1,000 facevalue bond

Bidamount dealer offers to buy from you, quoted in 32nds, 145 and12/32 % of par = 145.375% (i.e., 1.45375) of the face value, thereforethe bid is $1,453.75 = (1, 000 * 1.45375)

Treasury prices werepreviously quoted in

32nds.



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6-92


2020 Feb 15 8.5 145.12 145.15 +64 3.4730

What is the ask price? What does this mean?

How much did the price change from the previous day?

What is the YTM based on Ask price and why?

Askamount dealer is willing to sell to you, quoted in 32nds, 145 and15/32 % of par cent = 145.46875 % (i.e., 1.4546875) of the facevalue, therefore the ask is = $1,454.69 = ($1,000 * 1.4546875)

+64/32 of 1 percent or 2 percent; a tick size = 1/32

Asked yield is 3.4730%, lower than coupon rate since this is apremium bond and sells for more than the face value.

Treasury prices were previouslyquoted in 32nds.



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2020 Feb 15 8.5 145.12 145.15 +64 3.4730

What is bid-ask spread, what does this represent?AskBid = $1,454.69 - 1,453.75 - = $0.94 and represents thedealers profit.

Treasury prices were previouslyquoted in 32nds.

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