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Bond Pricing and Valuation Techniques

This document provides an overview of pricing bonds. It begins with a review of time value of money concepts like future value, present value, and valuation of annuities. It then discusses how to price zero-coupon bonds by discounting the bond's maturity value using the required yield. The relationship between a bond's price and its yield is also examined, noting that price and yield move in opposite directions. The document concludes by exploring how a bond's price can change based on factors like changes in its credit quality, movement toward maturity, or shifts in required market yields.

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Matt Courchaine
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7 views2 pages

Bond Pricing and Valuation Techniques

This document provides an overview of pricing bonds. It begins with a review of time value of money concepts like future value, present value, and valuation of annuities. It then discusses how to price zero-coupon bonds by discounting the bond's maturity value using the required yield. The relationship between a bond's price and its yield is also examined, noting that price and yield move in opposite directions. The document concludes by exploring how a bond's price can change based on factors like changes in its credit quality, movement toward maturity, or shifts in required market yields.

Uploaded by

Matt Courchaine
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

BUS 424: Fixed Income Security Analysis

CHAPTER 2: PRICING A BOND


I.

Review of TVM

Pn=P0 (1+r )n

A. Future value:

n: number of periods
P: future value n periods from now (in dollars)
Pn: original principal (in dollars)
r: interest rate per period

r=

annualinterest rate
number of interest is paid per year

B. Future value of an ordinary annuity the same amt of money is invested periodically, with the first pmt
occurring one period from now

P n= A

(1+ r)n1
r

NOTE: use this formula to calculate the FV of a bond held with reinvestment

C. Present value the amt that must be invested today to realize a specific future value

PV =Pn

1
n
(1+r )

D. Present value of series of future values


n

PV =
t=1

rt
(1+r )t

E. Present value of an ordinary annuity

PV = A

II.

1
(1+r )n
r

Pricing a Bond
A. Pricing Zero-Coupon Bonds

P=

M
n
(1+r )

B. Price-Yield Relationship a fundamental property of a bond is that its price changes in the opposite
direction from a change in the required yield
NOTE: the point where the graph intersects the price axis is the maximum price for the bond and
corresponds to the value of the undiscounted cash flows of the bond (i.e., the sum of all coupon
payments and the par valye)
C. Relationship b/w coupon rate, required yield, and price as yields in the marketplace change, the only
variable that can change to compensate the investor for the new required yield is the price of the bond
When market yield rises above the coupon rate, the price adjusts so that the investor can realize
additional interest
When market yield falls below the coupon rate, the price rises above par value because otherwise
they would be getting a coupon rate in excess of the required yield
Coupon rate < required yield Discount bond
Coupon rate = required yield Par
Coupon rate > required yield Premium bond
D. Reasons for change in the price of a bond
1. There is a change in the required yield due to changes in the issuers credit quality
2. There is a change in the price of the bond selling at premium(discount) without any changes in
required yield because the bond is moving toward maturity
3. There is a change in the required yield owing to a change in the yield on comparable bonds (i.e., a
change in the yield required by the market)

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