Chapter 6: Valuing Bonds
6.1 Bond Cash Flows, Prices, and Yields
● Bond terminology
○ A bond is a security sold by governments and corporations to raise money from
investors today in exchange for promised future payments.
○ The bond certificate indicates the amounts and dates of all payments to be made
○ The final repayment made is called the maturity date of the bond.
○ The time remaining until the repayment date is known as the term of the bond
○ Bonds typically make two types of payments to their holder.
■ Coupons are the interest payments of a bond.
■ Face value is the value repaid at maturity
○ The coupon rate formula determines the coupon payment of the bond.
● Zero-Coupon Bonds
○ The zero-coupon bonds do not make coupon payments, only the face value of the
bond on the maturity date.
○ Zero-coupon bonds trade at a discount, at a price lower than the face value,
because of the value of time money.
● Yield to Maturity
○ The IRR of an investment opportunity is the discount rate at which the NPV of teh
cash flows of the investment opportunity is equal to zero.
○ The yield to maturity (YTM) of a bond is the discount rate that sets the present
value of the promised bond payments equal to the current market price of the
bond.
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, ■ It is the return you will earn as an investor from holding the bond to
maturity and receiving the promised face value payment.
or YTM = FV/P - 1
● Where P is the current price and FV is the face value
● Risk-Free Interest Rates
● Coupon Bonds
○ Coupon bonds pay investors their face value at maturity and make regular coupon
interest payments.
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6.1 Bond Cash Flows, Prices, and Yields
● Bond terminology
○ A bond is a security sold by governments and corporations to raise money from
investors today in exchange for promised future payments.
○ The bond certificate indicates the amounts and dates of all payments to be made
○ The final repayment made is called the maturity date of the bond.
○ The time remaining until the repayment date is known as the term of the bond
○ Bonds typically make two types of payments to their holder.
■ Coupons are the interest payments of a bond.
■ Face value is the value repaid at maturity
○ The coupon rate formula determines the coupon payment of the bond.
● Zero-Coupon Bonds
○ The zero-coupon bonds do not make coupon payments, only the face value of the
bond on the maturity date.
○ Zero-coupon bonds trade at a discount, at a price lower than the face value,
because of the value of time money.
● Yield to Maturity
○ The IRR of an investment opportunity is the discount rate at which the NPV of teh
cash flows of the investment opportunity is equal to zero.
○ The yield to maturity (YTM) of a bond is the discount rate that sets the present
value of the promised bond payments equal to the current market price of the
bond.
1
, ■ It is the return you will earn as an investor from holding the bond to
maturity and receiving the promised face value payment.
or YTM = FV/P - 1
● Where P is the current price and FV is the face value
● Risk-Free Interest Rates
● Coupon Bonds
○ Coupon bonds pay investors their face value at maturity and make regular coupon
interest payments.
2
