SEMINAR 2
S2
SOURCES OF FINANCING :
DEBT VS EQUITY
Characteristic Debt Equity
Redemption Yes No
Face Value
1. Valuation of Bonds
• Price = PV (Cashflow)
= PV (Coupons) + PV (Face Value)
2. Yields
• Yield to Maturity/Redemption Yield
• Rate of Return
(coupon + price change)/investment
3. Price vs Face Value
• Coupon rate = YTM, sell @ par
• Coupon rate > YTM, sell @ premium
• Coupon rate < YTM, sell @ discount
BONDS
1. Accrued Interest
• When an investor purchases a bond between
coupon payments, the investor must compensate
the seller of the bond for the coupon interest earned
from the time of the last coupon payment to the
settlement date of the bond.
1. Spot vs Forward
• Spot rate (aka zero-coupon rate) : current interest rate
for a stipulated period
• Forward rate : interest rate payable that commences n
months from the spot date for a stipulated period
Eg.
1-year spot = 7%
2-year spot = 8%
Find the Forward from year 1 to year 2, F1,2
TERM STRUCTURES
1. Yield Curve
• Yields vs Maturity
• Variations :
• Par yield
• Spot
• Annuity
TERM STRUCTURES
$1 800
Coupon = $100
20 years to maturity
$1 600 $1 000 face value
$1 000
$ 800
BOND
A B C
Coupon Rate 10% 8% 6%
Maturity Value US$1000 US$1000 US$1000
Time to Maturity 3 years 4 years 5 years
Expected YTM 12% ? 10%
Price ? US$906.5 ?
a) Calculate :
• Current market price of Bond A
• YTM of Bond B
b) Calculate the current market price of Bond C. Draw the yield curve as far
as the data permits and comment on this curve
c) Let us assume that we have the above 5 year to maturity US government
bond and a similar bond issued by the Singaporean government. What
does the difference between their yields tell you? Explain what would
happen if these 2 bonds offer different real yields?