Bond Valuation Professor Ronald Miolla. Agenda What is a bond? How are bonds valued? Interest rate changes and bond values.

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Presentation transcript:

Bond Valuation Professor Ronald Miolla

Agenda What is a bond? How are bonds valued? Interest rate changes and bond values.

What is a Bond? Issuer: IBM or the US Treasury Face or Principal value: $25000 Recorded as Liabilities on the balance sheet A source of financing. A=L+OE Term: 30 years Coupon: $ amount, 6 months, $1,250 Callable: can be paid back early, ex 10 years Yield is a calculation: 2,500/25,000=10%.

Bond Valuation A bond is just cash flows. Previous example: to the buyer it is a $25,000 cash outflow in the present. It returns a $1,250 annuity for 60 periods (semiannually), a cash inflow. It also is a $25,000 single payment cash inflow in year 30. The bonds price or value is the value of the two inflows at the current discount rate (yield to maturity, or interest rate).

Interest Rate Changes If rates go down, say to 3%, then the discount rate to value the bond is 3% rather than 10% => higher present value of the inflows (bond price). If rates go up, say 15% then the bond’s price goes down.

Summary A bond is a financial security. Bonds are used to finance a company or government. Bonds are contracted cash flows. Interest rate changes impact bond values.