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Derivatives

Derivatives. Lecture 7. Bond Prices. Example If today is October 2001, what is the value of the following bond? An IBM Bond pays $115 every Sept for 5 years. In Sept 2006 it pays an additional $1000 and retires the bond. The bond is rated AAA (WSJ AAA YTM is 7.5%) Cash Flows

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Derivatives

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  1. Derivatives Lecture 7

  2. Bond Prices Example If today is October 2001, what is the value of the following bond? An IBM Bond pays $115 every Sept for 5 years. In Sept 2006 it pays an additional $1000 and retires the bond. The bond is rated AAA (WSJ AAA YTM is 7.5%) Cash Flows Sept 02 03 04 05 06 115 115 115 115 1115

  3. Bond Prices Example continued If today is October 2001, what is the value of the following bond? An IBM Bond pays $115 every Sept for 5 years. In Sept 2006 it pays an additional $1000 and retires the bond. The bond is rated AAA (WSJ AAA YTM is 7.5%)

  4. Bond Prices & Yields Price Yield

  5. Yield To Maturity All interest bearing instruments are priced to fit the term structure This is accomplished by modifying the asset price The modified price creates a New Yield, which fits the Term Structure The new yield is called the Yield To Maturity (YTM)

  6. Yield to Maturity Example A $1000 treasury bond expires in 5 years. It pays a coupon rate of 10.5%. If the market price of this bond is 107.88, what is the YTM?

  7. Yield to Maturity Example A $1000 treasury bond expires in 5 years. It pays a coupon rate of 10.5%. If the market price of this bond is 107.88, what is the YTM? C0 C1 C2 C3 C4 C5 -1078.80 105 105 105 105 1105 Calculate IRR = 8.5%

  8. Bond Prices & Yields Price Yield

  9. Bond Price Sensitivity Bond B YTM = 3.50% Maturity = 5 years Coupon = 7% or $70 Par Value = $1,000 Price = $1,158.03 Bond A YTM = 4.00% Maturity = 8 years Coupon = 6% or $60 Par Value = $1,000 Price = $1,134.65

  10. Bond Price Sensitivity Bond B YTM = 4.25% Maturity = 5 years Coupon = 7% or $70 Par Value = $1,000 New Price =$1,121.57 Price dropped by 3.15 % Bond A YTM = 4.75% Maturity = 8 years Coupon = 6% or $60 Par Value = $1,000 New Price= $1,108.61 Price dropped by 2.30 % Yields increased 0.75%...prices dropped differently

  11. Problems • Class examples Homework FinCoach • 5 Bond price problems • 5 Bond YTM problems

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