1

Chapter 7
Valuation and
Characteristics of Bonds
General Valuation: The following 3
comments are valid for all kind of
assets.
 Book Value
Stated value from the firm’s Balance Sheet
 Market Value
The price for the asset at any given time--determined by supply and demand in the marketplace. Asset
can be bought or sold at this price.
 Intrinsic Value
Present value of the asset’s expected cash flow
 Investor estimates cash flows
 Investor determines required rate based on risk of asset and market conditions.
 4

In a perfect market where all investors have the

same expectations & risk aversion:
Market Value = Intrinsic Value
 5
Bonds
 Debt Instruments
 Bondholders are lending to the corporation (or, governments)
money for some stated period of time.
 Liquid Asset
 Corporate Bonds can be traded in the secondary market.
 Price at which a given bond trades is determined by market
conditions and terms of the bond.
 6
Bond Terminology
 Par Value
Usually $1,000. Also called the Face Value
 Coupon Interest Rate
Borrowers (firms) typically make periodic payments to the bondholders. Coupon rate is the percent of face
value paid every year.
 Maturity
Time at which the maturity value (Par Value) is paid to the bondholder.
 Indenture
Document which details the legal obligation of the corporation to the bondholders. The indenture lists all the
terms and conditions of the bond.
 7
Types of Bonds
 Debentures
 Subordinated Debenture
 Mortgage Bond
 Eurobond
 Convertible Bond
 Zero Coupon Bonds
 Junk Bond
 8
Bond Ratings
 Moody’s and Standard & Poors regularly monitor issuers’
financial conditions and assign a rating to the debt. Bond
rating shows the relative probability of default.
similar to a personal credit report

AAA Top Quality

Investment AA
Grade A
BBB
BB
B
Junk CCC
CC Low Quality
C No interest being paid
D Currently in Default
 9
Bond Ratings
 Bond Ratings can change due to many factors.
Caterpillar Corp debt was recently upgraded due to
fact that it appears that current 10 month strike has
not affected prospects of firm in any significant
manner.
Corporate Bond Ratings
Citicorp A-
GMAC BBB+
Bell South AAA
DuPont AA-
Phillip Morris A
Kroger BB+
Unisys BB-
Bethlehem Steel B+
Grand Union D
 10
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Company Issuing the Bond

 11
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Coupon Interest Rate

 12
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Coupon Interest Rate

Determines the Investor’s Periodic Cash Flow

 13
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Coupon Interest Rate

Determines the Investor’s Periodic Cash Flow

Cash Flow = Interest Payment = Coupon Rate x Par
= .06375 x 1000 = $63.75/Year
 14
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Year of Maturity
 15
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Year of Maturity

Determines the Time frame for the Investment

00 = year 2000, therefore in 1995 this is a 5 year investment
 16
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Current Yield (%)

 17
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Current Yield (%)

Anuual $ Coupon
= 63.75
Current Yield = = .066 = 6.6%
Market Price 966.25
 18
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Daily Trading Volume

 19
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Daily Closing Market Price

 20
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Daily Closing Market Price

Expressed as a % of Par
 21
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Daily Closing Market Price

Expressed as a % of Par

$Price = 965/8 x 10 = $966.25

 22
Bond Quotes
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Change from Previous Day’s Closing Price

 23
Bond Valuation Model
 Bond Valuation is an application of Present Value.
 The Value of the bond is the present value of all the
cash flows the investor receives as a result of
holding the bond.
 3 Cash Flows
Amount that is paid to purchase the bond (PV)
Periodic Interest Payments made to the bondholders
(PMT)
Payment of maturity value at end of Bond’s life.
 Other Terminology
Time frame for cash flows (N) = Bond’s Maturity
 Interest Rate for Time Value is the rate at which
future cash flows are being discounted to present.
 24
Bond Valuation Model
IBM Bond Timeline:
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Investor that purchases bond today (1995) for $966.25 will receive 5
annual interest payments of $63.75 and a $1,000 payment in 5 years.
 25
Bond Valuation Model
IBM Bond Timeline:
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

Investor that purchases bond today (1995) for $966.25 will receive 5
annual interest payments of $63.75 and a $1,000 payment in 5 years.

1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
 26
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00

Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
 27
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$59.03 $63.75
(1.08)

Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
 28
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

$63.75 1000.00
$59.03
(1.08)2
$54.66

Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
 29
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$59.03
$63.75
$54.66
(1.08)3
$50.61

Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
 30
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$59.03
$54.66
$63.75
$50.61 (1.08)4
$46.86

Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
 31
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$59.03
$54.66
$50.61
$63.75
$46.86
(1.08) 5
$43.39

Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
 32
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$59.03
$54.66
$50.61
$46.86
$43.39
$1000
(1.08) 5
$680.58
$935.12
Compute the Intrinsic Value for the IBM Bond given that
you require a 8% return on your investment.
 33
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$63.75 Annuity for 5 years
 34
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
 35
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
Vb = I(PV of Annuity) + PV of Par
 37
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
Vb = I(PV of Annuity) + PV of Par
= 63.75( 1 1
5 ) + 1000
5
.08 .08(1+.08) (1+.08)
 38
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
Vb = I(PV of Annuity) + PV of Par
= 63.75( 1 1
5 ) + 1000
5
.08 .08(1+.08) (1+.08)
= 63.75(3.9927) + 680.58
 39
Bond Valuation Model
Compute Bond’s Intrinsic Value
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

63.75 63.75 63.75 63.75 63.75

1000.00
$63.75 Annuity for 5 years
$1000 Lump Sum in 5 years
Vb = I(PV of Annuity) + PV of Par
= 63.75( 1 1
5 ) + 1000
5
.08 .08(1+.08) (1+.08)
= 63.75(3.9927) + 680.58
= 254.54 + 680.58 = 935.12
 40
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

45 45 45 45 45 45 45 45.00
1000.00
 41
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
Cur Net
Bonds Yld Vol Close Chg
AMR6¼24 cv 6 91¼ -1½
ATT 8.35s25 8.3 110 102¾ +¼
IBM 63/8 00 6.6 228 965/8 -1 / 8
Kroger 9s99 8.8 74 1017/8 -¼

Source: Wall Street Journal

1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

45 45 45 45 45 45 45 45.00
1000.00
Rather than receiving 4 annual payments of $90, the
bondholder will receive 4x2 = 8 semiannual payments
of 90÷2=$45.
 42
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

45 45 45 45 45 45 45 45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
 43
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

45 45 45 45 45 45 45 45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
Since interest is received every 6 months, need to use
semi-annual compounding
 44
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

45 45 45 45 45 45 45 45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
Since interest is received every 6 months, need to use
semi-annual compounding
1 1 1000
Vb = 45( .05 .05(1+.05)
8) +
(1+.05)
8

Semi-Annual 10%
Compounding 2
 45
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

45 45 45 45 45 45 45 45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
Since interest is received every 6 months, need to use
semi-annual compounding
1 1 1000
Vb = 45( .05 .05(1+.05)
8) +
(1+.05)
8

=45(6.4632) + 676.84
 46
Bond Valuation Model
Some Bonds Pay Interest Semi-Annually:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

45 45 45 45 45 45 45 45.00
1000.00
Compute the Intrinsic Value for the Kroger Bond given
that you require a 10% return on your investment.
Since interest is received every 6 months, need to use
semi-annual compounding
1 1 1000
Vb = 45( .05 .05(1+.05)
8) +
(1+.05)
8

=45(6.4632) + 676.84
= 290.85 + 676.84 = 967.68
 47
Yield to Maturity
 Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
 48
Yield to Maturity
 Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
Substitute the Market Price (P0) for Vb and
solve for kb where kb = Annual YTM
1 1  Par
P0    n
 n
k
 b k b (1  k b )  (1  k b )
 49
Yield to Maturity
 Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
Substitute the Market Price (P0) for Vb and
solve for kb where kb = Annual YTM
1 1  Par
P0    n
 n
k
 b k b (1  k b )  (1  k b )

Cannot Solve
Directly
 50
Yield to Maturity
 Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
IBM Corporate Bond:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

-966.25 63.75 63.75 63.75 63.75 63.75

1000.00
 51
Yield to Maturity
 Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
IBM Corporate Bond:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

-966.25 63.75 63.75 63.75 63.75 63.75

1000.00
??
+ ??
966.25
 52
Yield to Maturity
 Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
IBM Corporate Bond:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

-966.25 63.75 63.75 63.75 63.75 63.75

1000.00
??
+ ??
966.25
 53
Yield to Maturity
 Bondholder’s Expected Rate of Return.
If an investor purchases bond at today’s price and
hold it until maturity, what is the annual rate of return
that is earned?
IBM Corporate Bond:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

-966.25 63.75 63.75 63.75 63.75 63.75

1000.00
??
+ ??
966.25
1 1  1000
966.25  63.75  
 k b (1  k b )  (1  k b ) 5
5
 54
Yield to Maturity
1 1  1000
966.25  63.75  
 k b (1  k b )  (1  k b ) 5
5

Cannot Solve directly, must use a Financial Calculator

or the following Approximation Formula for YTM:
 55
Yield to Maturity
1 1  1000
966.25  63.75  
 k b (1  k b )  (1  k b ) 5
5

Cannot Solve directly, must use a Financial Calculator

or the following Approximation Formula for YTM:

YTM Approximation Formula

1000  Po

kb  n
1000  2 P0
3
 56
Yield to Maturity
IBM Corporate Bond:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

-966.25 63.75 63.75 63.75 63.75 63.75

1000.00
YTM Approximation Formula

1000  Po

kb  n
1000  2 P0
3
 57
Yield to Maturity
IBM Corporate Bond:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

-966.25 63.75 63.75 63.75 63.75 63.75

1000.00
YTM Approximation Formula
1000  966.25
1000  Po 63.75 
 5
n 
kb  1000  2(966.25)
1000  2 P0
3
3
 58
Yield to Maturity
IBM Corporate Bond:
1995 1996 1997 1998 1999 2000

0 1 2 3 4 5

-966.25 63.75 63.75 63.75 63.75 63.75

1000.00
YTM Approximation Formula
1000  966.25
1000  Po 63.75 
 5
n 
kb  1000  2(966.25)
1000  2 P0
3
3

 70.50
977.50
7.21%
 59
Interest Rate Risk
 Bond Prices fluctuate over Time
As interest rates in the economy change, required
rates on bonds will also change resulting in investor’s
intrinsic values changing and market prices changing.

Interest
Rates Vb
 60
Interest Rate Risk
 Bond Prices fluctuate over Time
As interest rates in the economy change, required
rates on bonds will also change resulting in investor’s
intrinsic values changing and market prices changing.

Interest
Rates Vb

Interest
Rates
Vb
 61
Interest Rate Risk
 Bond Prices fluctuate over Time
 62
Interest Rate Risk
 Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is
set to match current prevailing rates.
 63
Interest Rate Risk
 Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is set to match
current prevailing rates.
Over time, the prevailing rates may change, but the coupon rate is
fixed.
 64
Interest Rate Risk
 Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is set to match current
prevailing rates.
Over time, the prevailing rates may change, but the coupon rate is fixed.
Resulting in the actual price of the bond changing.
 65
Interest Rate Risk
 Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is set to match current
prevailing rates.
Over time, the prevailing rates may change, but the coupon rate is fixed.
Resulting in the actual price of the bond changing.

1995 AAA Bonds are currently yielding 6%

Purchase ATT 6s2015 Bond for $1000.00

 66
Interest Rate Risk
 Bond Prices fluctuate over Time
When bonds are originally issued, the coupon rate is set to match current
prevailing rates.
Over time, the prevailing rates may change, but the coupon rate is fixed.
Resulting in the actual price of the bond changing.

1995 AAA Bonds are currently yielding 6%

Purchase ATT 6s2015 Bond for $1000.00

1 1 1000
Vb = 60( .06
.06(1+.06)
20 ) +
(1+.06)
20

= $1,000
 67
Interest Rate Risk
1995 AAA Bonds are currently yielding 6%

Purchase ATT 6s2015 Bond for $1000.00

1998 AAA Bonds are currently yielding 9%

If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
 68
Interest Rate Risk
1995 AAA Bonds are currently yielding 6%

Purchase ATT 6s2015 Bond for $1000.00

1998 AAA Bonds are currently yielding 9%

If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)

1 1 1000
Vb = 60( .09
.09(1+.09)
17 ) +
(1+.09)
17

= $743.69
 69
Interest Rate Risk
1995 AAA Bonds are currently yielding 6%

Purchase ATT 6s2015 Bond for $1000.00

1998 AAA Bonds are currently yielding 9%

If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
Market Price for ATT6s2015 is now $743.69

2001 AAA Bonds are currently yielding 5%

If you want to sell the the ATT 6s2015

Bond, it must be priced to earn the
purchaser a competitive rate (required
rate = 5%)
 70
Interest Rate Risk
1995 AAA Bonds are currently yielding 6%

Purchase ATT 6s2015 Bond for $1000.00

1998 AAA Bonds are currently yielding 9%

If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
Market Price for ATT6s2015 is now $743.69

2001 AAA Bonds are currently yielding 5%

If you want to sell the the ATT 6s2015

Bond, it must be priced to earn the
purchaser a competitive rate (required
rate = 5%)

1 1 1000
Vb = 60( .05
.05(1+.05)
14) +
(1+.05) = $1,098.99
14
 71
Interest Rate Risk
1995 AAA Bonds are currently yielding 6%

Purchase ATT 6s2015 Bond for $1000.00

1998 AAA Bonds are currently yielding 9%

If you want to sell the the ATT 6s2015 Bond, it must be priced to
earn the purchaser a competitive rate (required rate = 9%)
Market Price for ATT6s2015 is now $743.69

2001 AAA Bonds are currently yielding 5%

If you want to sell the the ATT 6s2015
Bond, it must be priced to earn the
purchaser a competitive rate (required
rate = 5%)
Market Price for ATT6s2015 is now
$1,098.99
Bond Prices fall during
periods of rising interest
rates and rise during
periods of falling interest
rates.
 73
Bond Relationships

Bond Price changes in the opposite direction of the

interest rate changes
 74
Bond Relationships

Bond Price changes in the opposite direction of the

interest rate changes
If the coupon rate of a bond is less than the required rate
of investors, the bond will sell at a discount. Fig. 7-3.
As the maturity date approaches, the market value of the
bond approaches its par value. Fig 7-4, Table 7-2.
Everything else being equal, a bond with longer maturity is
more price sensitive to changes in interest rates than a
bond with shorter maturity.
 75
Bond Relationships

Bond Price changes in the opposite direction of the interest rate

changes.
If the coupon rate of a bond is less than the required rate of investors,
the bond will sell at a discount. Fig. 7-3.
As the maturity date approaches, the market value of the bond
approaches its par value. Fig 7-4, Table 7-2.
Everything else being equal, a bond with longer maturity is more price
sensitive to changes in interest rates than a bond with shorter
maturity.
Everything else being equal, a bond with higher coupon is less price
sensitive to changes in interest rates than a bond with lower coupon.
76