Chapter 10 Bond Prices and Yields

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Bond Characteristics Face or __________ value ___________for Corp. bonds) _____________________________ Indenture

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Bond Valuation The value (price) of a bond is the present value of future cash flows Bond cash flows: ◦____________________________________ Discount rate: ◦Cash flows are discounted at the __________ _________________________

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Bond Prices and Yields The yield to maturity (YTM) of a given bond is determined by market conditions and varies according to: ___________________________ Other features

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Bond Prices and Yields Prices and yields (required rates of return) are inversely related When yields are high, bond price is low

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Yield to Maturity The YTM of a bond is the annual percentage return, based on the bond price if: ◦ the bond is ____________________________ ◦all payments are ________________________ ◦coupon payments are ____________________ YTM is calculated as the “bond equivalent yield”

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Alternative Measures of Yield Effective annual yield Yield to Call ◦Call price replaces par ◦Call date replaces maturity Holding Period Yield (Realized compound yield) ◦Considers actual reinvestment rate ◦Considers any change in price if holding period is less than maturity

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Premium and Discount Bonds Premium Bond: price > par ◦Coupon rate _________ than yield to maturity ◦Bond price will ___________ to par over its life Discount Bond: price < par ◦Coupon rate _________ than yield to maturity ◦Bond price will ___________ to par over its life

Premium and Discount Bonds over Time Premium Bond Par Bond Discount Bond Maturity Price

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Default Risk and Ratings Rating companies ◦Moody’s Investor Service ◦Standard & Poor’s ◦Fitch Rating Categories ◦Investment grade ______________________ ◦Speculative grade

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Factors Used by Rating Companies Coverage ratios Leverage ratios Liquidity ratios Profitability ratios Cash flow to debt