How to value

Straight / Vanilla Bonds

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 Recap: What is a Straight Bond?

These are standard, “typical” bonds that

pay a series of Coupons followed by a Par
at maturity.

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 Straight Bond Payoff Timeline

Year 0 Year 1 Year 2 ⋯ → Year N

𝑃 𝐶 𝐶 ⋯ → 𝐶 + 𝑃𝑎𝑟

Price of Coupon payments every year, and

the bond Par at the bond’s maturity date.

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 Price of a Straight / Vanilla Bond
0
𝐶+ 𝑃𝑎𝑟0
𝑃=* +
+ 0
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀
+12

𝐶2 𝐶3 𝐶0 𝑃𝑎𝑟0
𝑃+ = 2
+ 3
+ ⋯+ 0
+ 0
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀

𝐶2 𝐶3 𝐶0 + 𝑃𝑎𝑟0
𝑃+ = 2
+ 3
+ ⋯+
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 0

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 Price of a Straight / Vanilla Bond

The equation simplifies if these 3 conditions hold:

𝐶2 = 𝐶3 = ⋯ = 𝐶0
𝑌𝑇𝑀2 = 𝑌𝑇𝑀3 = ⋯ = 𝑌𝑇𝑀0
𝑛<∞
𝐶2 1 𝑃𝑎𝑟0
𝑃+ = 1− 0
+ 0
𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀

Present Value of an
Annuity

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 Hills Inc.

Hills Inc. is evaluating a bond that is

offering 5% coupons with a $1,000 par
value and 5 year maturity.

What is the fair price of this bond if the appropriate

yield is 4%?

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 Hills Inc. (Solution)
0
𝐶+ 𝑃𝑎𝑟0
𝑃+ = * +
+ 0
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀
+12

𝐶2 𝐶3 𝐶0 𝑃𝑎𝑟0
𝑃+ = 2
+ 3
+ ⋯+ 0
+ 0
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀

𝐶2 𝐶3 𝐶0 + 𝑃𝑎𝑟0
𝑃+ = 2
+ 3
+ ⋯+
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 0

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 Hills Inc. (Solution)

𝐶2 𝐶3 𝐶0 + 𝑃𝑎𝑟0
𝑃+ = 2
+ 3
+ ⋯+
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 0

$50 $50 $50 + $1,000

𝑃+ = 2
+ 3
+ ⋯+
1 + 0.04 1 + 0.04 1 + 0.04 >

𝑃+ = $48.08 + $46.23 + $44.45 + $42.74 + $863.02

𝑃+ = $1,044.52

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 Hills Inc. (Alternative Solution)

Since the coupons (𝐶) remain unchanged,

the discount rate (𝑌𝑇𝑀) is constant, and the
bond’s lifetime (𝑛) is finite...

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 Hills Inc. (Alternative Solution)

... the bond’s cashflow stream is an Annuity.

We can apply the formula for the

PV of an Annuity.

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 Hills Inc. (Alternative Solution)

𝐶2 𝐶3 𝐶0 + 𝑃𝑎𝑟0
𝑃+ = 2
+ 3
+ ⋯+
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 0

𝐶2 1 𝑃𝑎𝑟0
𝑃+ = 1− 0
+ 0
𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀

$50 1 $1,000
𝑃+ = 1− >
+ >
0.04 1 + 0.04 1 + 0.04

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 Hills Inc. (Alternative Solution)

$50 1 $1,000
𝑃+ = 1− >
+ >
0.04 1 + 0.04 1 + 0.04

𝑃+ = $222.59 + $821.93

𝑃+ = $1,044.52

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 Did you get it?
Watch the example
again if you haven’t
quite got it yet.

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 Watson Plc

Watson Plc wants to issue 10,000 10 year

6% £100 bonds.

What is the price of each bond if the yield is 8%?

How much money will Watson Plc raise if all bonds

are sold?

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 Pause the video now and try solving it!

Hint: the process is exactly the same as in Hills Inc.

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 Watson Plc (Solution)
0
𝐶+ 𝑃𝑎𝑟0
𝑃+ = * +
+ 0
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀
+12

𝐶2 1 𝑃𝑎𝑟0
𝑃+ = 1− 0
+ 0
𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀

£6 1 £100
𝑃+ = 1− 2F
+ 2F
0.08 1 + 0.08 1 + 0.08

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 Watson Plc (Solution)

£6 1 £100
𝑃+ = 1− 2F
+ 2F
0.08 1 + 0.08 1 + 0.08

𝑃+ = £40.26 + £46.32

𝑃+ = £86.58

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 Watson Plc (Solution)

Given a price of £86.58 per bond, and

10,000 bonds being issued, Watson Plc
will be able to raise £865,800 if all bonds
are sold.

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 Watson Plc (Alternative Approach)

The Price of a bond can also be

calculated using ‘discount factor tables’
(“DF Tables”).

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 Watson Plc (Alternative Approach)

Discount Factor Tables summarise values

for the ‘root’ of the PV formulas.

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 Watson Plc (Solution using DF Tables)
Annuity Discount Factor Table

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 Watson Plc (Solution using DF Tables)
Single CF Discount Factor Table

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 Watson Plc (Solution using DF Tables)
0
𝐶+ 𝑃𝑎𝑟0
𝑃+ = * +
+ 0
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀
+12 𝐴IJ =

𝑃+ = 𝐶+ ×𝐴IJ + 𝑃𝑎𝑟0 ×𝑆IJ

𝑆IJ =

𝑃+ = £6×6.710 + £100×0.463

𝑃+ = £86.56

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 Watson Plc (Solution on Excel)

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 Watson Plc (Solution on Sheets)

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 Summary
Straight / vanilla bonds pay a series of coupons, followed by a Par at
maturity.

The value of a vanilla bond is equal to the Present Value of its Coupon
Payments and the Par Value, given its discount rate = yield.
0
𝐶+ 𝑃𝑎𝑟0
𝑃+ = * +
+ 0
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀
+12

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 Now have a go
at the quiz!

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