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CHAPTER 6
Interest Rates
&
Bond Valuation
What are we going to learn
in this chapter?
Bond Basics
 What are bonds? Why issue them?
 Who issues bonds?
 How does the process work?
 Etiler Gıda=> 1,000 TL; 10 years; 12 %
Bond Terminology
 Face Value (or Par Value):
 Coupon:
 Coupon Rate:
 Maturity:
 Price:
(Is the price in the previous example 1,000 TL?)
Bond Values and Yield
 As time passes, interest rates change in the
marketplace.
What happens to the cash flows of the bond
and the price of the bond?
 When interest rates rise, the bond is worth the
same? worth more? worth less?
Why?
 Yield to maturity (YTM)
Bond Valuation
 Suppose Pegasus were to issue a bond with 10 years
to maturity. The bond has an annual coupon of TL
80. Similar bonds have a yield to maturity of 8
percent. What would this bond sell for?
Bond Valuation
 To illustrate what happens as interest rates
change, suppose a year has gone by. The
Pegasus bond now has nine years to maturity.
If the interest rate in the market has risen to
10 percent, what will the bond be worth?
 Discount bond
Bond Valuation
 What would the Pegasus bond sell for if
interest rates had dropped by 2 percent
instead of rising by 2 percent? In this case,
again, there are nine years remaining.
 Premium bond
Bond Valuation
 Bond Value = PV of coupons + PV of face value
Semiannual Coupons
 If a bond has a coupon rate of 14 percent, but
it pays semiannually. The yield to maturity is
quoted at 16 percent. Maturity is 7 years.
What should be the price?
Interest Rate Risk
 What is interest rate risk?
 Time to maturity
 Coupon rate
Interest Rate Risk
Yield to Maturity
 Suppose we are interested in a six-year, 8
percent coupon bond. A broker quotes a price
of TL 955.14. What is the yield on this bond?
(face value assumed to be 1,000 TL)
Yield to Maturity
 A bond has a quoted price of $1,080.42. It has
a face value of $1,000, a semiannual coupon
of $30, and a maturity of five years. What is its
yield to maturity?
Debt vs. Equity
 Ownership & voting power
 Tax deductability
 Liability & bankruptcy
Inflation vs. Interest Rates
 Nominal rates are called “nominal” because
they have not been adjusted for inflation. Real
rates are rates that have been adjusted for
inflation.
 An investment is available that will be worth
$115.50 in one year. It costs $100 today. What
is the interest rate?
 What is the inflation is 5 %?
Inflation vs. Interest Rates
 The Fisher Effect defines…..
 (1 + R) = (1 + r)(1 + h)
Inflation vs. Interest Rates
 If investors require a 10 percent real rate
of return, and the inflation rate is 8
percent, what must be the exact nominal
rate?
END OF CHAPTER