CHAPTER 5

Bonds and Their Valuation

 Key features of bonds

 Bond valuation
 Measuring yield
 Assessing risk
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What is a bond?
 A long-term debt instrument in which
a borrower (Issuer) agrees to make
payments of principal and interest, on
specific dates, to the holders of the
bond.

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What is a bond
 A bond is a fixed interest financial asset
issued by governments, companies,
banks, public utilities and other large
entities.
 Bonds pay the bearer a fixed amount a
specified end date.

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Key Features of a Bond
 Par value – face amount of the bond, which
is paid at maturity (assume $1,000).
 Coupon interest rate – stated interest rate
(generally fixed) paid by the issuer. Multiply
by par to get dollar payment of interest.
 Maturity date – years until the bond must be
repaid.
 Issue date – when the bond was issued.
 Yield to maturity - rate of return earned on
a bond held until maturity (also called the
“promised yield”).
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Types of Bond ( wrt Return)
 Discount Bond - pays the bearer only at
the ending date (Maturity).
 Coupon Bond - pays the bearer a fixed
amount over a specified interval (month,
year, etc.) as well as paying a fixed
amount at the end date

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 Other types (features) of bonds
 Convertible bond – may be exchanged for
common stock of the firm, at the holder’s option.
 Put-able bond – allows holder to sell the bond
back to the company prior to maturity.
 Income bond – pays interest only when interest is
earned by the firm.
 Indexed bond – interest rate paid is based upon
the rate of inflation.

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Callable Bond
 A bond that can be redeemed by the
issuer prior to its maturity.
 Usually a premium is paid to the bond
owner when the bond is called.
 The main cause of a call is a decline in
interest rates.

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 The value of financial assets
0 1 2 n
k ...
Value CF1 CF2 CFn

CF1 CF2 CFn

Value  1
 2
 ...  n
(1  k) (1  k) (1  k)

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