Finance
Chapter 6 - Valuing Bonds
6.1 Bond Cash Flows, Prices, and Yields
- A Bond is a security sold by governments and corporations to raise money from
investors today in exchange for promised future payments.
- The terms of a bond are described as part of the Bond Certificate - which indicates
the amounts and dates of all payments to be made. These payments are made until a
finaal repayment date, the Maturity Date of the bond. The time remaining until the
repayment date is known as the Term of the bond.
- Typically, bonds make two types of payments to their holders:
1. Coupons: the promised interest payments of a bond.The amount of each coupon
payment is determined by the Coupon Rate:
2. Principal/Face Value: the notional amount we use to compute the interest
payments.
- A very simple type of bond is a Zero-Coupon Bond, which does not make coupon
payments. The only cash payment the investor receives is the face value of the bond
on the maturity date. An example of a zero-coupon bond is a treasury bill - a US
government bond with a maturity of up to one year.
- The present value of a future cash flow is less than the cash flow itself. This explains
that prior to its maturity date, the price of a zero-coupon bond is less than its face
value. So, zero-coupon bonds trade at a discount, so they are also known as Pure
Discount Bonds.
- The internal rate of return of a bond is called its Yield to Maturity (or yield):
"The yield to maturity of a bond is the discount rate that sets the present value of the
promised bond payments equal to the current market price of the bond."
- The Yield to Maturity for a zero-coupon bond is given by:
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Chapter 6 - Valuing Bonds
6.1 Bond Cash Flows, Prices, and Yields
- A Bond is a security sold by governments and corporations to raise money from
investors today in exchange for promised future payments.
- The terms of a bond are described as part of the Bond Certificate - which indicates
the amounts and dates of all payments to be made. These payments are made until a
finaal repayment date, the Maturity Date of the bond. The time remaining until the
repayment date is known as the Term of the bond.
- Typically, bonds make two types of payments to their holders:
1. Coupons: the promised interest payments of a bond.The amount of each coupon
payment is determined by the Coupon Rate:
2. Principal/Face Value: the notional amount we use to compute the interest
payments.
- A very simple type of bond is a Zero-Coupon Bond, which does not make coupon
payments. The only cash payment the investor receives is the face value of the bond
on the maturity date. An example of a zero-coupon bond is a treasury bill - a US
government bond with a maturity of up to one year.
- The present value of a future cash flow is less than the cash flow itself. This explains
that prior to its maturity date, the price of a zero-coupon bond is less than its face
value. So, zero-coupon bonds trade at a discount, so they are also known as Pure
Discount Bonds.
- The internal rate of return of a bond is called its Yield to Maturity (or yield):
"The yield to maturity of a bond is the discount rate that sets the present value of the
promised bond payments equal to the current market price of the bond."
- The Yield to Maturity for a zero-coupon bond is given by:
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