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fiche topic 2

Uploaded by

blanche.dechauliac2
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Topic 2

1. Bond Basics
A bond is a debt security, where:
 Issuer (like a government or corporation) borrows money.
 Investor lends money and receives regular interest (coupon) payments.
 At maturity, the issuer repays the principal.
Key Features:
 Face Value/Par Value: The amount paid back at maturity.
 Coupon Rate: Annual interest paid as a percentage of face value.
 Maturity Date: When the principal is repaid.
2. Bond Pricing
The price of a bond is determined by calculating the present value of its expected future cash
flows (coupons and principal). The formula is:
P=∑
( C
) +
1
( 1+r ) ( 1+r )T
t

Where :
- P=¿ Price of the bond
- C = Coupon payment
- r =¿ Yield (discount rate)
- t=¿ Time period
- FV =¿ Face Value
- T =¿ Number of years to maturity

Example Calculation (Annual Payment): For a 2-year bond with:


 Face Value: $100
 Coupon Rate: 4%
 Yield: 3%
1. Coupons: $4 annually ($100 × 4%).
2. Present Value of Coupons:
4
PV of Year 1= =3.883
1.03
104
PV of Year 2Coupon+ Principal= =98.02
( 1.03 )2

3. Total Price :

P=3.3883+ 98.02=101.91

3. Semi-Annual Coupon Payments


When coupons are paid semi-annually, adjustments are made:
 Coupon payments are halved.
 Yield is halved for each period.
Adjusted Formula:

(( ) ) (
C
2 FV
P=∑ +
)
t 2T
r r
1+ 1+
2 2

Example Calculation (Semi-Annual Payment):


 Coupon: 2% semi-annually ($2 per payment).
 Yield: 1.5% per period (3% annually divided by 2).
 Number of Periods: 4 (2 years × 2 payments/year).
1. Present Value of Cash Flows:

2 2 2 102
P= + + +
1.015 ( 1.015 ) ( 1.015 ) ( 1.015 )4
2 3

Calculating these:

P=1.97 +1.94+1.91+ 96.11=101.93

4. Yield to Maturity (YTM)


The YTM is the discount rate that equates the present value of all future cash flows to the
current bond price. It reflects the overall return if held to maturity.
For example: If a bond with a Face Value of $1000, 5 years to maturity, and a 7% annual
coupon is priced at $1235.67, then:
\text{YTM} = 2\% \quad \text{(since the bond’s PV of $1235.67 matches cash flows
discounted at 2%)}

5. Duration (Macaulay Duration)


Duration measures a bond's sensitivity to interest rate changes:

Duration=
∑ t × PV of Cash Flow
Price
It’s expressed in years and indicates the average time to receive the bond’s cash flows.

Example: if the present value of all cash flows is $765.89 and the bond price is $88.13:
765.89
Macaulay Duration= =8.69 years
88.13

6. Inverse Relationship: Price and Yield


The bond price is inversely related to the yield:
 If yield increases, bond prices fall (discount).
 If yield decreases, bond prices rise (premium).
7. Zero-Coupon Bonds
For zero-coupon bonds, there are no periodic coupon payments. The price is simply the
present value of the face value:

FV
P=
( 1+r )T
Example : For a zero-coupon bond promising $100 in a year, with current market value of
$90.91:

100
r= −1=10 %
90.91

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