## 07CashFlowAnalysisBonds-2013.pdf-Bond Example 6 • What isshowing page 18-25 out of 26

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Bond Example 6

•

What is the price of a bond with a yield rate of

6%, coupon rate of 8%, paid semi-annually,

maturing in 2 years and 1 month?

•

EEA08 - CF Examples.xls

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Yield on a Bond – How much will you

receive?

•

Purchase a bond for $1000.

The issuing

corporation will pay bond holder $45 interest on

the $1000 face (par) value of the bond every 6

months and repay the $1000 at end of 10 years.

•

After 2 years the bond holder sold the bond to

someone else for $880

•

(a) What is the yield on the 1

st

holder’s

investment?

•

(b) If the 2

nd

holder keeps the bond for its

remaining 8 year life, what is the yield to maturity

on his/her investment?

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Company Issuing Bonds

•

Facts:

–

Need to raise $1,000,000

–

1000 bonds with a face value of $1000 will be issued,

maturing in 5 years

–

Coupons will be paid semi-annually

–

Current company bond with a maturity of 4 years, a

coupon rate of 12%, paid semi-annually, sells for $102

–

New debt will not have a significant impact on the

company capital structure

•

What would be an appropriate coupon rate –

assume the rate must be in 0.25% increments?

•

How much capital will be raised?

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The Yield Curves

Ascending

Yield Curve

This is the

common shape

in developed

countries. It

shows that yield

rises for longer

maturities.

Descending Yield

Curve

This shape

shows that short

term interest rates

are higher than long

term rates. This

shape is often seen

when the market

expects interest

rates to fall.

Flat Yield Curve

Short term rates

are the same as

long term rates.

Humped Yield

Curve

Shape

often seen when

the market

expects that

interest rates will

first rise (fall)

during a period

and fall (rise)

during another.

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Canadian Yield Curve

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Yield Curves

Canadian Yield Curves

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

0.045

0

5

10

15

20

25

30

35

Yield to Maturity

Rate

03/01/2006

02/01/2007

02/01/2008

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Cash flow diagram example 1

•

$500,000 (par/face value) 5-year bond with a

8% coupon payable semi-annually. (You

receive a payment of 4% of the bond face

value every 6 months and, at redemption,

receive the face value.)

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Basic Issues on Bonds

•

There can be a large difference between the Coupon

rate and the yield, interest today (later MARR)

•

Use the coupon rate and the frequency of payments to

calculate the size of the payment (this is an annuity

cash flow) - the face value is a single future cash flow

•

Then, use the interest rate (yield or MARR or whatever

is required) to calculate the present value of the bond

•

If we have a bond $1,000, coupon 10%, compounded

half yearly, matures in 5 years and interest today is 8%

•

First, the half yearly payment is = 1000*0.1/2 = 50

•

Then, we have PV = 1000(P/F, 4%, 10)+50(P/A, 4%,10)

•

Note the 8%/2= 4% and the N = 5*2 = 10 periods