Fin 327

11/1/2015

OUTLINE

FIN 327: Chapters 10 and 11

Readings

Chapter 10 (except

“Bond Pricing in Excel”

p. 303-304, “Yield to

Call” p. 306-307, and

“The Expectations

Theory” p. 322-324)

Chapter 11.1 Interest

rate risk, p. 337-346

Exercises

1. Bond Structure

2. Bond Pricing

3. Bond Quotes

4. Yield-to-Maturity

5. Credit Risk

Chapter 10: 1. e. j., 4,

6, 22, 30; CFA 1a

Chapter 11: 2, 4

6. Holding Period Ret.

7. Interest Rate Risk

8. Callable Bonds

9. Indexed Bonds - TIPS

1

2

Example

• Face value (or par value): Payment to bondholder at

maturity of bond, typically $1,000.

• Coupons: Periodic interest payments. The coupon

rate is expressed as an annual rate per dollar of par

value. Semi-annual coupons are most common. In

that case, the semi-annual payments are equal to

half of the annual coupon rate, times the par value. A

zero-coupon bond is a special case with no coupon

payments, just a par value.

Cash flows of a 2-yr bond with $1,000 par value and 8%

annual coupon rate:

Bond payments

1. Bond Structure

$1,040

$40

6 months

1. Bond Structure

• If you have a 2-yr 8% coupon bond and you hold it

until maturity (that’s called a buy-and-hold strategy),

does it mean that your realized return over the 2-yr

period will be 8%?

• Not necessarily because there is reinvestment risk.

The coupons that you receive periodically must be

reinvested at current interest rates. For example,

your realized return would be less than 8% if the

coupons were reinvested at 6%.

$40

$40

1 year 18 months 2 years

1. Bond Structure

• If you are trying to predict your realized return by

making assumptions about the rate at which

coupons will be reinvested, this is called horizon

analysis.

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1. Bond Structure

2. Bond Pricing

• Example from the

book: 2-yr bond with

10% coupons paid

annually (purchase for

$1,000)

Present

value of

coupons

Bond

Value

• If coupons reinvested...