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

Page 18
18
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


Page 19
19
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?


Page 20
20
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?


Page 21
21
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.


Page 22
22
Canadian Yield Curve


Page 23
23
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


Page 24
24
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.)


Page 25
25
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


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