9-bond prices and yields

7/26/2019 9-Bond Prices and Yields

1/28

Comm 324 W. suoSlide 1Slide 1

Bond Prices and

Yields


2/28


Objective

To review the principles of bond pricing and to

examine the determinants of credit risk. Bond Characteristics Bond ricing and !T" Taxation #ss$es %efa$lt &isk and &atings


3/28

Comm 324 W. suoSlide 'Slide '

Characteristics (ace or par val$e Co$pon rate

)ero co$pon bond Compo$nding and pa*ments #ndent$re #ss$ers

rovisions of Bonds Sec$red or $nsec$red Call provision

Convertible provision &etractable and extendible +p$ttable, bonds (loating rate bond

-now *o$r bond


4/28

Comm 324 W. suoSlide /Slide /

0 price of the bond0 interest or co$pon pa*ments

0 n$mber of periods to mat$rit*

0 the appropriate semiann$al compo$nding disco$nt rate

Bond ricing


5/28

Comm 324 W. suoSlide Slide

0 /3 +S4,

0 1333

0 53 periods

0 136 +S4,

0

7813.91

Solving for rice: '3*r; 86

Co$pon Bond; ar 0 71;333


6/28


Bond rices at %ifferent #nterest &ates +86 Co$ponBond; Co$pons aid Semiann$all*


7/28Comm 324 W. suoSlide 9Slide 9

The #nverse &elationship Between

rices and %isco$nt rate

rices and disco$nt rates +reero; the val$e of the bond approaches

the s$m of the cash flows



!ields

!ield to mat$rit* bond equivalent yield

!ield to first call

?ffective 4nn$al !ield

C$rrent !ield +4nn$al #nterest@"arket rice,


9/28Comm 324 W. suoSlide ASlide A

!ield to "at$rit*

#nterest rate that makes the present val$e of the

bonds pa*ments e



!ield to "at$rit* ?xample

'3 *r "at$rit* Co$pon &ate 0 86;

C$rrent price 0 71;295.95

Solve for 0 5.36



!ield "eas$res

?ffective ann$al *ield

+1.3',2 1 0 5.3A6

C$rrent *ield +ann$al interest@market price,

783 @ 71;295.95 0 5.29 6

Note: contrary to what is used in industry, out

textbook refers to as the yield to maturity



!ield to Call

?xample: S$ppose a 86 co$pon; '3*ear mat$rit* bond isselling for 7113; and is callable in 13 *ears at a call priceof 71133. !ield to mat$rit* and *ield to call will be

calc$lated $sing:


13/28Comm 324 W. suoSlide 1'Slide 1'

Bond rices and !ields for a Callable Bond


14/28Comm 324 W. suoSlide 1/Slide 1/

oldingeriod &et$rn: Single eriod

olding period ret$rn:

?xample: D D *ears; semiann$al compo$nding 30 71333

#n 5" the rate falls to 96; 1071358.

olding period ret$rn

013.86 +semiann$al,



oldingeriod &et$rn: "$ltiple eriod

Compo$nd *ield vs. !T"

&e



?xample

Two*ear bond selling at par; 136 co$pon paid once a

*ear. (irst co$pon is reinvested at 86; then

(

0A.316

Similarl*; if first co$pon is reinvested at 136; the

reali>ed holding period ret$rn is 136



Growth of #nvested ($nds



rice aths of Co$pon Bonds


19/28Comm 324 W. suoSlide 1ASlide 1A

)eroCo$pon Bonds and Taxation #ss$es

(or constant *ields; disco$nt bond prices rise over time andpremi$m bond prices decline over time

Original iss$e disco$nt +O#%, bonds price appreciation+based on constant *ield, is taxed as ordinar* income

rice changes stemming from *ield changes are taxed ascapital gains if the bond is sold



?xample: Tax

'3*ear bond with /6 co$pon rate; iss$ed at an 86 !T"D if sold one *ear later; when

!T"096; for a '56 income tax and a 236 capital gains tax:

30/A.5AD

1+86,0'.55D1+96,05'1.59

#ncome tax +22'.55 2/A.5A, 3.'5

/3 3.'5 12.8'

= +

+ =

+5'1.59 '.55, 3.23 1.5

1.8' 1.5 '1./'/3

+5'1.59 /A.5A, '1./' A3.

A3. @ /A.5A 15.6

CG tax

Total taxAfter tax income

Rate of return

= =

= + =

= +

+ =

= =



=hat #s a Credit &atingH

#ndependent; thirdpart* opinion of an entit* or sec$rit* credit



=h* %o &atings "atterH

The credit market is act$all* larger +both in si>e and

vol$me, than the e


23/28


24/28

Comm 324 W. suoSlide 2/Slide 2/

The &ating #nd$str*

Mohn "ood* started assessing railwa* bonds in 1A38 Lo reg$lation; no oversight; no independent research =hen it existed; financial information was not timel* and of d$bio$s


25/28


Bond &ating Classes


26/28


CREDIT RATINGS & THE CANADIAN FIXED INCOME MARKET 26

&atings N %efa$lt &ates

Best

Credits

Average

Credits

Worst

Credits

Hardly ever

default

Sometimes

default

Frequentlydefault

AAA AA A BBB BB B CCC CC C D

0.3% 0.6% % 3 % !% 30% " #0%

+?stimated c$m$lative defa$lt rates over 9 *ears b* rating categor*,

$nvestment rade S&e'ulative rade


27/28


"ethods are proprietar*

4cco$nting ratios

Coverage ratios Jeverage ratio Ji


28/28

Sinking f$nds S$bordination of f$t$re debt

%ividend restrictions

Collateral

rotection 4gainst %efa$lt

9-bond prices and yields

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