Ch 8: Interest Rates and Bond Valuation

Face value/Par value of a bond: The amount repaid at the end of the loan.

Coupon Rate: The annual coupon value divided by its face value

Maturity: The number of years until the face value is paid

Yield to Maturity (YTM): The interest rate required in the market on a bond.

Bond present value = Present value of the coupons + Present value of the face value
                    = C [1 - 1/(1+r)^T ] / R + F/(1+r)^T

C = coupon payment each period, calculated using the coupon rate
r = Discount rate per period (market rate:own), yield to maturity
T = Number of periods
F = Bonds face value

Current yield = coupon payment value/present bond value


Interest Rate Risk for Bonds:
1) All other things being equal, the longer the time to maturity, the greater the interest risk. The present value of the face value will be much more volatile with a long term bond.


2) All other things being equal, the lower the coupon rate, the greater the interest rate risk. The bond with the higher coupon has a larger flow early in its life, so its value is less sensitive to changes in the discount rate


Zero Coupon Bond: A bond that pays no coupons at all and is offered at a price much lower than its face value.