bond pricing basics

how would we determine the value of a risk free bond that pays fixed promised coupons of C and the face value F at maturity

using the present value concept

what’s the other word for r_f when you are talking about bonds specifically

spot rate per period

how would this formula be different for a zero coupon bond (“pure discount bond)

C=0, so this is the whole formula

its more common to talk about a bond in terms of its ________ rather than its ___________

yield rather than price

what is the YTM of a bond

yield to maturity (y)

define yield to maturity

the constant discount rate that sets the present value of a bonds promised cashflows equal to its current market price

(like IRR in a regular investment)

therefore, using maths, a higher yield will lead to a __________ price

lower!!

can the yield be interpreted as the bond’s expected return when held to maturity

like in certain situations but BARELY EVER so don’t assume this

what is a bond’s coupon rate

the percentage of face value that is paid as a coupon every year

what is a bond’s current yield (completely different from ‘yield’ talked about earlier btw)

percentage of current market price that is paid as a coupon every year

at maturity, a bond pays…

BOTH coupon and principal

note - look bak at the letcture reordings to see if u can hear him go over slides 85 and 86

okay

when does a bond trade at par

when market price = face value

when does a bond trade at discount

when market price < face value

when does a bond trade at a premium

when market price > face value

3 reasons why bonds are risky

default risk

inflation risk

interest rate risk

default risk

applies to corporate bonds

not for governments since they can either raise taxes or print money to meet obligations

BUT

some countries like eurozone ones can’t print money actually so this still might apply

inflation risk

can erode the real value of a bond’s cashflow

so then what does the risk adjusted market interest rate involve to account for inflation

.

interest rate risk

changes in interest rates change bond prices

longer term bonds tend to be more price sensitive

(this will be looked at more in another module - ECN132)