Bond Valuation
Excel and Bond Valuations (double click on Excel Sheet below) page-2
Excel and Bond Valuations (double click on Excel Sheet below) page-3
Excel and Bond Valuations (Bond Function) (double click on Excel Sheet below) page-4
page-5 Bond Price Sensitivity to YTM Bond price $1, 800 Coupon = $100 annually 20 years to maturity $1, 000 face value $1, 600 Notice: bond prices and YTMs are inversely related. $1, 400 $1, 196. 36 $1, 200 $1, 000 $850. 61 $ 800 $ 600 Yields to maturity, YTM 4% 6% 8% 10% 12% 14% 16%
page-6 Interest Rate Risk and Time to Maturity Bond values ($) Interest rate 1 year 5% 2, 000 30 years $1, 047. 62 10 15 30 -year bond 1, 500 1, 000 $1, 047. 62 1, 000. 00 956. 52 20 $1, 768. 62 916. 67 1 -year bond $916. 67 500 $502. 11 5 10 15 20 Interest rates (%) Value of a Bond with a 10% Coupon Rate for Different Interest Rates and Maturities (assume annual payments) 1, 0
T 7. 21 Factors Affecting Bond Yields What factors affect observed bond yields? u u u The real rate of interest Expected future inflation Interest rate risk Default risk premium Taxability premium Liquidity premium page-7
Bond Ratings – Investment Quality page-8 n High Grade u u Moody’s Aaa and S&P AAA – capacity to pay is extremely strong Moody’s Aa and S&P AA – capacity to pay is very strong n Medium Grade u u Moody’s A and S&P A – capacity to pay is strong, but more susceptible to changes in circumstances Moody’s Baa and S&P BBB – capacity to pay is adequate, adverse conditions will have more impact on the firm’s ability to pay
Bond Ratings - Speculative n Low Grade u u u Moody’s Ba, B, Caa and Ca S&P BB, B, CCC, CC Considered speculative with respect to capacity to pay. The “B” ratings are the lowest degree of speculation. n Very Low Grade u u Moody’s C and S&P C – income bonds with no interest being paid Moody’s D and S&P D – in default with principal and interest in arrears page-9
Bond Characteristics and Yield page-10 n The yield depends on the risk characteristics of the bond n Which bonds will have the higher yield, all else equal? u u u Debenture higher YTM than secured debt Subordinated debenture higher YTM than senior debt A bond with a sinking fund lower YTM than one without A callable bond higher YTM than a non-callable bond A puttable bond lower YTM than a non-puttable bond.
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