Video 20 Topic 4 2 Bond Valuation and

Video 20 (Topic 4. 2): Bond Valuation and Yields FIN 614: Financial Management Larry Schrenk, Instructor

Topics 1. Discounted Cash Flow (DCF) Method 2. Bond Valuation 3. Bond Yields 1. Yield to Maturity (YTM) 2. Yield to Call (YTC) 3. Current Yield

Discounted Cash Flow (DCF) Method Asset Value = PV(Cash Flows) Examples: Stock Price = PV(Dividends) Project Value = PV(Net Annual Cash Flows)

Bond Valuation Bond Value = PV(Cash Flows) Two Cash Flows: (Semi-Annual) Fixed Coupons Par Value (at Maturity)

Bond Valuation Bond Value = PV(Coupons) + PV(Par Value) Coupons are an Annuity Par Value is One Time Payment

Bond Valuation Formula for Bond Valuation PV(Coupons) PV(Par Value)

Bond Valuation: Example 1 What is the present value of a four year, semiannual bond with a par value of $1, 000. 00 and a coupon rate of 8% if the discount rate is 6%?

Bond Valuation: Example 2 What is the present value of a four year, semi-annual bond with a par value of $1, 000. 00 and a coupon rate of 8% if the discount rate is 6%? N=8 (= 4 x 2) I%=6 PV=0 ◄ Select @, then [ALPHA] [ENTER] PMT=-40 (= (1000 x 0. 08)/2) FV=-1000 P/Y=2 C/Y=2 PMT: END BEGIN PV = 1070. 20 Note: Negatives

Yield to Maturity (YTM) Discount rate such that Price = PV(cash flows) Expected return if the bond purchased at a fair value

Yield to Maturity: Example What is the YTM of a five year, semi-annual bond with a par value of $1, 000 and a coupon rate of 9% if the bond is selling for $990? N=10 (= 5 x 2) I%=0 ◄ Select @, then [ALPHA] [ENTER] PV=-990 PMT=45 (= (1000 x 0. 09)/2) FV=1000 P/Y=2 C/Y=2 PMT: END BEGIN PV (YTM) = 9. 25% Note: Negatives

Yield to Maturity Notes YTM = expected return only when just purchased. YTM versus realized/actual yield

Yield to Call (YTC) The yield of a bond if it is called, i. e. , you were to buy and hold the security until the call date. Calculation: Same as YTM except: N = Periods to the Call Date (not Maturity) FV = Call Price (not Par Value)

Yield to Call: Example What is the YTC of a five year, semi-annual bond with a par value of $1, 000 and a coupon rate of 9% if the bond is selling for $990, the call price is $1, 100 and the call date is two years? N=4 (= 2 x 2; N is Periods to Call) I%=0 ◄ Select @, then [ALPHA] [ENTER] PV=-990 PMT=45 (= (1000 x 0. 09)/2) FV=1100 (FV is Call Price) P/Y=2 C/Y=2 PMT: END BEGIN PV (YTM) = 14. 09% Note: Negatives

Current Yield Interest payment relative to price Current Yield = Annual Interest Payment / Bond Price It is not the bond’s expected return (that is YTM). YTM = Current Yield + Capital Gains Yield

Current Yield: Example Find the current yield for a 9% annual coupon bond that sells for $887 and has a par value of $1, 000. Current Yield = $90 / $887 = 0. 1015 = 10. 15%

Video 20 (Topic 4. 2): Bond Valuation and Yields FIN 614: Financial Management Larry Schrenk, Instructor