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Bond Pricing and Yields Tutorial

This document provides an overview of bond pricing and yields. It includes examples of calculating bond prices from yield curves, determining coupon rates for bonds priced at par, and computing spot rates from given bond prices. It also discusses yields to maturity for default-free bonds and corporate bonds, including calculating promised and expected yields and default premiums.

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Zhenyi Zhu
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124 views2 pages

Bond Pricing and Yields Tutorial

This document provides an overview of bond pricing and yields. It includes examples of calculating bond prices from yield curves, determining coupon rates for bonds priced at par, and computing spot rates from given bond prices. It also discusses yields to maturity for default-free bonds and corporate bonds, including calculating promised and expected yields and default premiums.

Uploaded by

Zhenyi Zhu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Finance

Tutorial 2

1. Bond prices and yields

Assume the following spot rates:

Maturity (years) 1 2 3 4 5
Spot Rate 3% 3.2% 3.4% 3.5% 3.6%

a. Consider a five-year default-free bond with face value $1000 and an annual coupon
rate of 5%. Without doing any calculations, can you tell if the bond is trading at a
discount, at par or at premium?
b. Using the yield curve provided in the table above, find the price of this bond. Use
Excel to find the YTM of this bond.
c. Consider a four-year default-free bond with annual coupon payments and a face
value of $1000 that is issued at par. Using the yield curve above, what is the coupon
rate of this bond? You should be able to solve this part using a simple calculator,
without using Excel.

a. Check Excel
b. Check Excel
c. Let C be the annual coupon payment. Solving the equation

C C C C 1000
1000 = + 2
+ 3
+ 4
+
(1.03) (1.032) (1.034) (1.035) (1.035) 4

we find that C=34.8792. Therefore, the annual coupon rate has to be 3.49%.

2. Term Structure of Interest Rates

A one-year zero-coupon bond with face value $100 sells for $96; a two-year zero-coupon
bond with face value $100 sells for $92; and a three-year 6% coupon bond (assuming
the coupons are paid annually) with face value of $100 has a yield to maturity of 4%.
Calculate the term structure of interest rates (the 1-year, 2-year, and 3-year spot rates) in
this economy, assuming no arbitrage opportunities exist.

Solution

100
r1 = − 1 = 4.17%
96
100
r2 = − 1 = 4.26%
92
6 6 106 6 6 106
P3 = + + = 105.55 = + +  r3 = 3.98%
1.04 1.04 2
1.04 3
1.0417 1.0426 2
(1 + r3 )3

1
3. Coupons and YTM

Consider a five-year, default free security with annual coupon payments 5% and a face
value of $1,000 that is issued at par.

a) Without doing any calculations, what is the YTM of this bond.


b) If the YTM increased to 5.2%, what would the new price be?

a. As bond trades at par, it’s YTM should be equal to the coupon of 5%.

4. Corporate Bonds

A 10-year bond of a firm in severe financial distress has a coupon rate of 14% and sells
for $900. The bond has a face value of $1000 and makes its coupon payments annually.
The firm is currently renegotiating the debt, and it appears that the lenders will allow the
firm to reduce coupon payments on the bond to one-half the originally contracted amount.
The firm can handle these lower payments.

a. Using Excel, compute the promised yield to maturity of the bond.


b. Using Excel, compute the expected yield to maturity of the bond (to be discussed
in Lecture 5)
c. What is the default premium of the bond? (to be discussed in Lecture 5)

Excel Solution

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