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Bond Valuation
Bond Valuation
CONTENTS
Introduction Bond Returns
coupon rate current yield spot interest rate yield to maturity yield to call
INTRODUCTION
Bonds are Long-term fixed income securities. Debentures are also long-term fixed income securities. Both of these are debt securities.
The two major categories of bonds are government bonds & corporate bonds. There are the two main features of bonds such as callability and convertibility.
BOND RETURNS
COUPON RATE:It is the nominal rate of interest fixed and printed on the bond certificate. It is calculated on the face value of the bond. It is the rate at which interest is payable by the issuing company to the bondholder.
A bonds sensitivity to changes in market interest rate increases at a diminishing rate as the time remaining until its maturity increases. The price changes resulting from equal absolute increases in market interest rates are not symmetrical, i.e. for any given maturity, a decrease in market interest rate causes a price rise that is larger than the price decline that results from an equal increase in market interest rate.
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Bond price volatility is related to the coupon rate, which implies that the percentage change in a bonds price due to a change in the market interest rate will be smaller if its coupon rate is higher.
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BOND RISKS
Two types of risk are associated with investment in bonds, namely default risk and interest rate risk.
DEFAULT RISK:Default risk refers to the possibility that a company may fail to pay the interest or principal on the stipulated dates. Poor financial performance of the company leads to such defaults.
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BOND DURATION
Duration is the weighted average measure of a bonds life. The various time periods in which the bond generates cash flows are weighted according to the relative size of the present value of those flows. The formula for computing duration d is:(t) (Ct) d= (1 + k)t Ct
(1 + k) t
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