BUSINESS & FINANCE STUDY NOTES
BOND
VALUATION
Price • YTM • Current Yield • Duration
Formulas • Solved Examples • Practice Questions
Zero-Coupon Semiannual Yield to Call Interest Rate Risk
9 Pages | Quick Revision | Exam Ready
, BOND VALUATION Business & Finance Study Notes
1. What is a Bond?
A bond is a loan from investors to a company or government. The issuer promises to pay fixed interest (the
coupon) at regular intervals and to repay the face value at maturity. The price of a bond is the present value of
these promised cash flows, discounted at the return the market requires (the yield to maturity, YTM).
Key Terms
Term Meaning
Face (par) value, F Amount repaid at maturity. Usually $1,000.
Coupon rate Annual interest as a % of face value.
Coupon payment, C Coupon rate x Face value (e.g. 8% x $1,000 = $80 a year).
Maturity, n Number of years (or periods) until the face value is repaid.
The discount rate that makes the PV of all bond cash flows equal the market price. It is the
Yield to maturity (YTM), r
bond's required return.
Call provision Right of the issuer to repay the bond early at a set call price.
Credit rating Opinion on default risk (AAA is strongest; BBB- and above is "investment grade").
Types of Bonds
Type Cash flows Note
Coupon bond Regular coupons + face value at maturity Most common
Zero-coupon bond Only the face value at maturity Sold at a deep discount
Perpetual bond (consol) Coupons forever, no maturity Price = C / r
Callable bond Issuer may repay early at the call price Investor faces call risk
Floating-rate bond Coupon changes with a reference rate Price stays close to par
Premium, Par or Discount?
Condition Bond sells at Reason
Coupon rate > YTM Premium (price > face value) Coupons are better than what the market now offers
Coupon rate = YTM Par (price = face value) Coupons match the market
Coupon rate < YTM Discount (price < face value) Coupons are worse than what the market now offers
As maturity gets closer, the price of a premium or discount bond moves toward its face value ("pull to par"). Risks: interest rate
risk, credit (default) risk, call risk, reinvestment risk, inflation risk and liquidity risk.
Page 2 of 9
BOND
VALUATION
Price • YTM • Current Yield • Duration
Formulas • Solved Examples • Practice Questions
Zero-Coupon Semiannual Yield to Call Interest Rate Risk
9 Pages | Quick Revision | Exam Ready
, BOND VALUATION Business & Finance Study Notes
1. What is a Bond?
A bond is a loan from investors to a company or government. The issuer promises to pay fixed interest (the
coupon) at regular intervals and to repay the face value at maturity. The price of a bond is the present value of
these promised cash flows, discounted at the return the market requires (the yield to maturity, YTM).
Key Terms
Term Meaning
Face (par) value, F Amount repaid at maturity. Usually $1,000.
Coupon rate Annual interest as a % of face value.
Coupon payment, C Coupon rate x Face value (e.g. 8% x $1,000 = $80 a year).
Maturity, n Number of years (or periods) until the face value is repaid.
The discount rate that makes the PV of all bond cash flows equal the market price. It is the
Yield to maturity (YTM), r
bond's required return.
Call provision Right of the issuer to repay the bond early at a set call price.
Credit rating Opinion on default risk (AAA is strongest; BBB- and above is "investment grade").
Types of Bonds
Type Cash flows Note
Coupon bond Regular coupons + face value at maturity Most common
Zero-coupon bond Only the face value at maturity Sold at a deep discount
Perpetual bond (consol) Coupons forever, no maturity Price = C / r
Callable bond Issuer may repay early at the call price Investor faces call risk
Floating-rate bond Coupon changes with a reference rate Price stays close to par
Premium, Par or Discount?
Condition Bond sells at Reason
Coupon rate > YTM Premium (price > face value) Coupons are better than what the market now offers
Coupon rate = YTM Par (price = face value) Coupons match the market
Coupon rate < YTM Discount (price < face value) Coupons are worse than what the market now offers
As maturity gets closer, the price of a premium or discount bond moves toward its face value ("pull to par"). Risks: interest rate
risk, credit (default) risk, call risk, reinvestment risk, inflation risk and liquidity risk.
Page 2 of 9
