Calculating Future Bond Prices

Calculating Future Bond Prices

Realized Compound Yield
Yield Adjustments for Tax-Exempt Bonds

Calculating Future Bond Prices
Where:
P
f
= estimated future price of the bond
C
i
= annual coupon payment
n = number of years to maturity
hp = holding period of the bond in years
i = expected semiannual rate at the end of the holding
period
hp n
p
hp n
t
t
i
f
i
P
i
C
P
2 2
2 2
1
) 2 1 ( ) 2 1 (
2 /

=
+
+
+
=


Calculate the future price of the bond

Calculate the future price of the bond
rate 10%, t =25 bond with promised YTM = 12%, face value
$1000
Assume expected market YTM decline to 8% after 5 years
future price after 5 years to estimate the expected YTM
Pf = ?
20 years, and the market YTM of 8 %.
n-hp = 20 years or
2n-2hp (50-10) = 40 periods


future price of the bond = $1,197.94
















Future price of the bond












Realized Compound Yield

Rate of return actually earned on a bond given
the reinvestment of the coupons at constant rate
The return that is actually earned over a given
time period.


0 . 1
bond of price Purchase
dollars future Total
RCY
2 / 1

=
n
Realized Compound Yield
Assume: F = 1000 C = $80 t=4 years
reinvestment of the annual 8% coupon (=$80 per annum).
Assuming we reinvest these coupons at 8%, we have the
following cash flows on the bond:






= .08
0 . 1
$1000
$1360.49
RCY
4 / 1

=
Realized Compound Yield

RCY = .08
If we reinvest the coupons at >8% we accumulate
>$1360.49(ending value)
and earn an annual return(RCY) > .08
and if < 8%
accumulate <$1360.49 and
earn an annual return(RCY) < .08.
Calculating Future Bond Prices
Yield Adjustments for Tax-Exempt Bonds
Municipal bonds, Treasury issues, and many agency
obligations possess one common characteristic: Their
interest income is partially or fully tax-exempt
For fully tax-exempt bonds



where: FTEY = fully taxable yield equivalent
i = the promised yield on the tax exempt bond
T = the amount and type of tax exemption
T - 1
i
FTEY =
Example
A taxable bond has a yield of 8% and a municipal bond
has a yield of 6%

If the investor is in a 40% tax bracket, which bond do the investor
prefer?



8%(1 - .4) = 4.8%
The after-tax return on the corporate bond is 4.8%, compared to a 6%
return on the municipal
T - 1
i
FTEY =