Beruflich Dokumente
Kultur Dokumente
Mr. Al Mannaei
Third Edition
What is Bond ?
• Debt instrument issued by a government or a
corporation in order to finance projects or
activities.
• A form of loan.
– Issuer : lender :
• Negotiable instruments.
What is Bond ?
Why issuing bonds?
•Governments : to finance infrastructure projects:
schools, roads, power stations..etc.
• Is payment guaranteed ?
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
How to price a bond ?
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
2 2
C1 + F N
0 0
1
PB = 1
1
4 5 (1 + i)
Coupon rate & Market Yield
Example (Continue) :
if you sell the bond after 6 months for $1050.
Calculate the market yield ?!
2 2
0 0
1 1
4 5
How to price a bond ?
• Example 1 : Consider 3 Years Bond with
face value of $1000 and Coupon rate 8% ,
Current market rate is 10% , Calculate the
price of the Bond ?
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
How to price a bond ?
• Example 1 : Consider 3 Years Bond with
face value of $1000 and Coupon rate 8% ,
Current market rate is 10% , Calculate the
price of the Bond ?
How to price a bond ?
• Example 2 : Consider 3 Years Bond with
face value of $1000 and Coupon rate 5% ,
Current market rate is 5% , Calculate the
price of the Bond ?
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
How to price a bond ?
• Example 2 : Consider 3 Years Bond with
face value of $1000 and Coupon rate 5% ,
Current market rate is 5% , Calculate the
price of the Bond ?
How to price a bond ?
Example 3: Consider a 1 year bond with a
face value of $1000 and a coupon rate of 8%
compounded annually, current market yield
is 5% , calculate the price of the bonds ?
How to price a bond ?
Example 3: Consider a 1 year bond with a
face value of $1000 and a coupon rate of 8%
compounded annually, current market yield is
5% , calculate the price of the bonds ?
1.Press (CMPD) bottom press EXE
2.Press EXE on (Set) choose END press EXE
3.Press EXE on (n) entre 1 press EXE
4.Press EXE on (I) entre 5 press EXE
5.Ignore PV ( press down )
6.Press EXE on PMT ENTRE 80 press EXE
7.Go back for PV press SOLVE.
How to price a bond ?
Example 3: Consider a 1 year bond with a face
value of $1000 and a coupon rate of 8%
compounded annually, current market yield is
5% , calculate the price of the bonds ?
n= 1
I=5
PV= ?
PMT=80
FV=1000
C/Y=1
Coupon rate & Market IR
How Does the Market IR & Coupon rate affect Bond
price ?
Coupon rate & Market IR
How Does the Market IR & Coupon rate affect Bond
price ?
If :
Coupon rate Greater Market IR >>> bond price higher than par ( issued at
premium )
Coupon rate Lower Market IR >>> bond price lower than par ( issued at
discount)
Coupon rate = Market IR >>> bond price equal par (issued at par)
Market IR & Bond Price
Negative relationship between i & Bond Price
– Increasing i ; decrease Bond Price.
– Decreasing i ; increase Bond Price.
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
Zero Coupon Bonds
• No periodic coupon payments.
• Issued at discount from par.
• Single payment of par value at maturity.
FV
PB = n
(1 + i)
Zero Coupon Bond
• How to price Zero Coupon Bonds ?
Semi-annual, Quarterly ,
Annual monthly, daily
FV FV
PB = n
PB = mn
(1 + i) i
(1 + )
m
PB is simply PV of FV represented by par value, discounted at market rate.
Example
• if you want to purchase a Company XYZ
zero-coupon bond that has a $1,000 face
value and matures in 3 years compounded
annually, and you would like to earn 10%
per year on the investment, what is the
price of the bond ?
FV
PB = n
(1 + i)
Example
• if you want to purchase a Company XYZ
zero-coupon bond that has a $1,000 face
value and matures in 3 years compounded
semi-annually, and you would like to earn
10% per year on the investment, what is
the price of the bond ?
FV
PB = mn
i
(1 + )
m
Example
• In the previous example if the
compounding frequency increase , Bond
price will :
– Decrease
– Increase
– No Change
Compounding Frequency increase
FV
PB = n
(1 + i)
Zero bond
• Mariam bought a bond mature after 3 years
for 1000 BD. The coupon rate and market
yield = 8%.
• Marwa bought zero-bond mature after 3
years for 1000 BD. The market yield is 8%.
• What if both bond defaulted after year 2 ?!
Year 0 1 2 3
Bond Yields
• Market Yield (Interest Rate)
– Yield to Maturity
– Expected Yield
– Realized Yield
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
Yield to Maturity (YTM)
• YTM : Investor's expected yield if bond is
held to maturity and all payments are
reinvested at same yield.
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
• The longer until maturity, the less valid
the reinvestment assumption
• Example:
– Bond A mature after 30 years pay 8%.
– Bond B mature after 5 years pay 8%.
– Which bond most likely will change the coupon rate ?!
Yields calculation
• The Bond price , Coupon rate & maturity
will be given and the Yield (i) has to be
calculated .
• The Yields can be calculated through
– Trail & error.
– Financial calculator.
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
YTM Example
• Investor buys 5% percent coupon
(semiannual payments) bond for $951.90;
bond matures in 3 years. Solve the bond
pricing equation for the interest rate (i)
such that price paid for the bond equals PV
of remaining payments
C1 C 2 due C under
N + FN
the
bond. PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
YTM Example
• Investor buys 5% percent coupon
(semiannual payments) bond for $951.90;
bond matures in 3 years. Solve the bond
pricing equation for the interest rate (i)
such that price paid for the bond equals PV
of remaining payments due under the bond.
25 25 1,025
951.90 = 1
+ 2
+ ... 6
(1 + (i / 2) ) (1 + (i / 2) ) (1 + (i / 2) )
YTM Example
• Investor buys 5% percent coupon
(semiannual payments) bond for $951.90;
bond matures in 3 years. Solve the bond
pricing equation for the interest rate (i) such
that price paid for the bond equals PV of
remaining payments due under the bond.
I: n: FV: PV: PMT:
Answer :
Expected Yield
• Predicted yield for a given holding period
• Almost same as YTM but the expected
holding period is shorter .
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
Realized Yield
• Realized Yield: actual rate of return, given
the cash flows actually received and their
timing.
C1 C2 CN + F N
PB = 1
+ 2
+ ... N
(1 + i) (1 + i) (1 + i)
D n
CFt
t 1 (1 i)
t
– CF : Coupons payment
– t: time of payment
– i: interest
– n: number of years
Duration Example
• Suppose we have a bond with a 3-year
term to maturity, an 8% coupon paid
annually, and a market yield of 10%.
Duration is:
Duration
• If the yield increases to 15%:
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