Fixed Income LOS a Calculate Fixed-Income Valuation

10% Annual-Pay Bond Cash Flows Per

$100 of Par Value
Fixed Income (1) T0 T1 T2 T3 T9 T10

Introduction to 10 10 10 10 10
Fixed-Income Valuation 100

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LOS a Calculate Fixed-Income Valuation LOS a Calculate Fixed-Income Valuation

Calculating a Bond’s Price 10% 10-Year Semiannual-Pay Bond

10-year, 10% annual coupon, market discount rate PMT = coupon / 2 = $100 / 2 = $50
(required rate of return or required yield) = 12%
N = 2 × # of years to maturity = 10 × 2 = 20
10 10 10 10 10 + 100
+ 2
+ 3
+ ... + 9
+ = 88.70
(1.12) (1.12) (1.12) (1.12) (1.12)10
I/Y = discount rate / 2 = 12 / 2 = 6%

N = 10; PMT = 10; FV = 100; I/Y = 12; PV = –88.700 FV = par = $1,000

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LOS a Calculate Fixed-Income Valuation LOS a Calculate Fixed-Income Valuation

Semiannual Coupon Payments Calculate a Zero-Coupon Bond Price

10% semiannual coupon, 10-year bond $100 par zero-coupon bond matures in 2.5 years,
If the annualized YTM is 12%, semiannual at an annualized discount rate (YTM) of 6%. With a
discount rate is 6%, and value is: periodicity of 2, the value is:
5 5 5 5 105 N = 2.5 × 2 = 5, PMT = 0, FV = 100,
+ 2
+ 3
+ ... + 9
+ = 88.53
1.06 1.06 1.06 1.06 1.0610 I/Y = 6 / 2 = 3 CPT PV = –86.261
100
N = 20; I/Y = 6; PMT = 5; FV = 100; PV = –88.530 = 86.261
(1.03 )5
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LOS b Calculate Fixed-Income Valuation LOS b Calculate Fixed-Income Valuation

Calculating a Market Discount Rate Yield to Maturity

3-year, 8% annual coupon bond, priced at 90.393
Calculate the market discount rate (IRR).
N = 3; PMT = 8; FV = 100; PV = –90.393; I/Y = 12%
This is the yield-to-maturity (YTM) and assumes:
1. Held-to-maturity
2. All payments made
3. Coupon payments reinvested at YTM
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5-year, 7% annual coupon bond, priced at 102.078
Calculate the market discount rate (IRR).
CPT
N = 5; PMT = 7; FV = 100; PV = –102.078; I/Y = 6.5%
This is the yield to maturity (YTM) and assumes:
1. Held to maturity
2. All payments made
3. Coupon payments reinvested at YTM
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LOS b Identify Fixed-Income Valuation LOS b Identify Fixed-Income Valuation

Relationships Relationships
Yield up → Price down; Price down → Yield up Convexity: Price increase from decrease in yield is
Yield down → Price up; Price up → Yield down larger than price decrease from increase in yield.

Maturity Effect: Values of bonds with longer

coupon rate > YTM → price > par (premium) maturities are more sensitive to changes in YTM.

coupon < YTM → price < par (discount) Coupon Effect: Values of bonds with lower coupons
are more sensitive to a change in YTM.
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LOS b Identify Fixed-Income Valuation LOS b Identify Fixed-Income Valuation

Price-Yield Relationship Option-Free Bond Price-Yield

Semiannual-Pay 6% 3-Year Bond Curve
Price
At 3%: I/Y = 1.5% N = 6 FV = 1,000 PMT = 30 For an option-free bond, the
CPT PV = $1,085.46 price-yield curve is convex
toward the origin.
At 6%: I/Y = 3% N = 6 FV = 1,000 PMT = 30 1,085.46
CPT PV = $1,000.00 1,000.00
Price falls at a decreasing
rate as yields increase.
At 12%: I/Y = 6% N = 6 FV = 1,000 PMT = 30 852.48

CPT PV = $852.48
YTM
3% 6% 12%
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LOS b Identify Fixed-Income Valuation

Constant-Yield Price Trajectory

A premium bond (e.g., 8% 8% bond,
A premium bond (e.g., a 8% bond trading at
bond trading at YTM of 4%) 3
years to
$1,112.03
1,142.430 YTM of 3%)

maturity
A par value bond (e.g., a 8% bond trading
at A par of
YTM value
8%) bond (e.g., 8% bond
$1,000.00
1,000.00
trading at YTM of 8%)
M
A discount bond (e.g., a 8% bond trading
at YTM of 12%)
A discount bond (e.g., 8%
$901.65
901.654
bond trading at YTM of 12%)
Time
Time to3 Maturity
years
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