BondPricing

Thebondequation
Equatesabondspricetothediscounted
presentvalueofthefuturecashflows
associatedwiththebond
T

ct
F
Pbond =
t +
T
1+y
1+y
(
t=1 (
t)
T)

Review:Compounding
Thefuturevalueof$1investedatyforN
years:
N
FV =$11+y
(
)

Years
1
2
3
4
5
10
20

2%
$1.02
$1.04
$1.06
$1.08
$1.10
$1.22
$1.49

Future value of $1
Interest rate
5%
$1.05
$1.10
$1.16
$1.22
$1.28
$1.63
$2.65

8%
$1.08
$1.17
$1.26
$1.36
$1.47
$2.16
$4.66

12%
$1.12
$1.25
$1.40
$1.57
$1.76
$3.11
$9.65

Review:Compounding
Ifinterestiscompoundedsemiannually:
2N

y
FV =$1 1+
2
Years
1
2
3
4
5
10
20

2%
$1.02
$1.04
$1.06
$1.08
$1.10
$1.22
$1.49

Interest rate
5%
$1.05
$1.10
$1.16
$1.22
$1.28
$1.64
$2.69

8%
$1.08
$1.17
$1.27
$1.37
$1.48
$2.19
$4.80

12%
$1.12
$1.26
$1.42
$1.59
$1.79
$3.21
$10.29

Example
ChoosingbetweentwoGICs
MetLifeInsuranceCo.offersa10yrGICthat
promisestopay8.25%perannumfor10years.
ExecutiveLifeInsuranceCo.offersa10year
GICthatpromisestopay8.10%perannum
compoundedsemiannually.

Example
Comparefuturevalues:
Gic
Rate
Met Life
8.25%
Executive 8.10%

Nper
1
2

Value in 10 yrs
$22,094,239.14
$22,122,881.39

Review:Discounting
Thepresentvalueof$1tobereceivedinN
yearsgivenaninterestrateofy:
PV =

Years
1
2
3
4
5
10
20

$1
(1+y)

=$11+y
(
)

Present value of $1
Interest rate
2%
5%
$0.98
$0.95
$0.96
$0.91
$0.94
$0.86
$0.92
$0.82
$0.91
$0.78
$0.82
$0.61
$0.67
$0.38

8%
$0.93
$0.86
$0.79
$0.74
$0.68
$0.46
$0.21

12%
$0.89
$0.80
$0.71
$0.64
$0.57
$0.32
$0.10

Review:Discounting
Or,ifinterestiscompoundedsemiannually:
2N

y
PV =$1 1+
2

Years

Present value of $1 (Semiannual compounding)

Interest rate
2%
5%
8%
1
$0.98
$0.95
$0.92
2
$0.96
$0.91
$0.85
3
$0.94
$0.86
$0.79
4
$0.92
$0.82
$0.73
5
$0.91
$0.78
$0.68
10
$0.82
$0.61
$0.46
20
$0.67
$0.37
$0.21

12%
$0.89
$0.79
$0.70
$0.63
$0.56
$0.31
$0.10

Annuity
Acashflowof$cperyearforKyearsiscalled
aKyearannuity.
Forexample,atwoyearannuitypays$cone
yearfromnow,and$ctwoyearsfromnow.
Iftheinterestrateisy,thenthepresentvalueof
thisannuityis
$c $c
+

P =
2
(1+y) (1+y)

PartialPeriodDiscounting
Supposethenextpaymentonanannuityisdue
inlessthanafulldiscountingperiod

105
days

Last
Payment

Now

260
days

Next
Payment

PartialPeriodDiscounting
Theproperdiscountingformulainthiscaseis
P=

$c
(1+y)

Notice
the
exponent

260
365

PartialPeriodDiscounting
Asecondpaymentdueoneyearafterthefirst
paymentwouldhavepresentvalue
P=

$c

Notice
the
exponent

(1+260
365)

(1+y)

BondBasics:Yield
Pricequotes
Cleanordirty?
Invoiceprice

Accruedinterest

Currentyield
Equalstheannualcouponpaymentdividedbythe
bonds(clean)price
cF
yc =
P

BondBasics:Yield
Simpleyieldtomaturity
Correctscurrentyieldfordragtopar
StandardquoteinJapanesebondmarket

cF +
ys =

F P
T

365

BondBasics:Yield

Yieldtomaturity
Yieldtocall
Yieldtoaveragelife
Holdingperiodyield

BondBasics:Dates
Dates
Dateddate
Issuedate
Tradedate
Settlementdate

Couponperiod
Daycountconventions(ACT/ACT;30/360)
Oddfirstcoupons

Example
HerearethreeUSTreasurybonds
Original Issue
Coupon
Auction Date
Issue Date
Dated Date
Maturity Date

5-yr T-Note
6
7/23/97
7/31/97
7/31/97
7/31/02

First Coupon Date

Day of Week
First Coupon Pay Date
First Coupon Period

10-yr T-Note
6 7/8
5/8/96
5/15/96
5/15/96
5/15/06

1/31/98

11/15/96

30-yr T-Bond
7 5/8
2/9/95
2/15/95
2/15/95
2/15/25
8/15/95

2/2/98
184

11/15/96
184

8/15/95
181

AccruedInterest
Interestaccrueslinearlyduringcouponperiod

Last
Coupon
Date

Next
Coupon
Date

Settlement
Date

AccruedInterest
Forexample
Original Issue
5-yr T-Note
10-yr T-Note
Coupon
6
6 7/8
Issue Date
7/31/97
5/15/96
First Coupon Date
1/31/98
11/15/96
Maturity Date
7/31/02
5/15/06
Pricing Date
2/22/99
2/22/99
Next Coupon Date
7/31/99
5/15/99
Previous Coupon Date
1/31/99
11/15/98
Current Coupon Period
181
181
Days of Accrued Interest
22
99
Percent of Coupon Period Elapsed
12.155%
54.696%
Accrued Interest (per $100 par)
$0.36
$1.88
Excel's ACCRINT function

$0.36

$1.85

30-yr T-Bond
7 5/8
2/15/95
8/15/95
2/15/25
2/22/99
8/15/99
2/15/99
181
7
3.867%
$0.15
$0.15

YieldtoMaturity
Theyieldtomaturity(ytm)onabondisthe
IRRonthebondscashflowtomaturity.
Tocalculateytm,youneedthebondsprice,its
couponrate,andnumberofcouponsremaining.
Forexample,considerabondwithncoupon
paymentsremainingandapricePperdollarof
principalvalue.

Price/YieldRelationship
Therelationshipbetweenthisbondsprice,P,
anditsyieldtomaturity,y,isgivenbythe
formula:
n

P =
i=1

whereq =

y 1i +q
2

(1+ )

1
y 1n+q
2

(1+ )

days from settlement to next coupon date

days in current coupon period

YieldGivenPrice:Example
Original Issue
5-yr T-Note
10-yr T-Note
Coupon (percent per annum)
6
6 7/8
Maturity Date
7/31/02
5/15/06
Pricing Date
2/22/99
2/22/99
Remaining Coupons
7
15
Next Coupon Date
7/31/99
5/15/99
Previous Coupon Date
1/31/99
11/15/98
Current Coupon Period
181
181
Days of Accrued Interest
22
99
Percent of Coupon Period Elapsed
12.155%
54.696%
Accrued Interest (per $100 par)
$0.36
$1.88
Clean Price: Hundreds
102
110
32nds
29
0
Clean Price: Decimal
$102.91
$110.00
Dirty Price:
$103.27
$111.88
Yield to Maturity
5.07%
5.20%

30-yr T-Bond
7 5/8
2/15/25
2/22/99
52
8/15/99
2/15/99
181
7
3.867%
$0.15
126
16
$126.50
$126.65
5.66%

PriceGivenYield:Example
Original Issue
5-yr T-Note
10-yr T-Note
Coupon
6
6 7/8
Maturity Date
7/31/02
5/15/06
Pricing Date
2/22/99
2/22/99
Remaining Coupons
7
15
Days of Accrued Interest
22
99
Percent of Coupon Period Elapsed
12.155%
54.696%
Accrued Interest (per $100 par)
$0.36
$1.88
Yield to maturity
5.07%
5.20%
"Dirty" price
$103.26
$111.88
"Clean" price
$102.90
$110.00
Hundreds
102
110
32nds
29
0

30-yr T-Bond
7 5/8
2/15/25
2/22/99
52
7
3.867%
$0.15
5.67%
$126.56
$126.41
126
13

ThePrice/YieldRelationship
Price/yield relationship
for an 8% 30-yr bond
$300.00
$250.00
$200.00
$150.00
$100.00
Bond Price
$50.00
$0.00

2.00%
3.40%
4.80%
6.20%
7.60%
9.00%
10.40%
11.80%
13.20%
14.60%
16.00%
Yield to Maturity

ANoteonExcelFunctions
Calendarfunctions
Subtractingtwodates
Days360
Yearfrac
Coupdays;Coupdaybs;Coupdaysnc;Coupnum

Financialfunctions
Accrint
Price

QuickCheck
Describetheeffectofwithinyear
compounding.
Whatisthedifferencebetweenabondsclean
priceanditsinvoiceprice?
Identifyatleastthreemeasuresofbondyield.
Whataretheprosandconsofeach?
Characterizetherelationshipbetweenabonds
priceanditsyield(tomaturity).

AppliedProblem
OnThurs,October19,2000,theUSTreasurys
105/8ofAugust2015(maturingonAugust31,
2015),wasquotedforsettlementonFriday,
October20,2000at145:15(ask).Whatwas
theimpliedyieldtomaturityatthisprice?
Onthesameday,theUSTreasurys91/8of
May2018(maturingonMay15,2018),was
quotedatayieldtomaturityof5.98%.What
wastheimpliedpriceatthisyield?