Summary Chapter 6: valuing bonds

Chapter 6: Valuing bonds
1. The bond market

B ONDS

= Debt instrument

= Financing by borrowing money



 Bond
Security that obligates the issuer to make specified payments to the bondholder
 Face value (par value or principal value)
Payment at the maturity of the bond
 Coupon
The interest payments made to the bondholder
 Coupon rate
Annual interest payment as a percentage of face value



BONDS AT INCEPTION /CREATION




 5-year bond example

 Coupon of 2% every year

 At inception, most bonds typically sell for their face value, but this depends on the coupon and yield
the maturity (see further)

, 2. Interest rates and bond prices

WARNING

 The coupon rate IS NOT the discount rate used in the Present Value calculations.

 The coupon rate merely tells us what cash flow the bond will produce > Since
the coupon rate is listed as a %, this misconception is quite common

 The discount rate is the rate at which cash flows can be invested > Therefore in
the context of bonds, we use a required rate of return as discount rate



The theoretical price of a bond is the present value of all cash flows generated by the bond (i.e. coupons
and face value) discounted at the required rate of return




Cpn is commonly used as an abbreviation for coupon



Bond prices are quoted as a percentage of par  Par value x price % = $ Price



Cash flows to an investor in the 1.25%
coupon bond maturing in 2018