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ADM2350 (26)

Chapters 7 + 8.docx

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William F Rentz

Interest Rates and Bond Valuation 1 1- t   (1+r)  F Bond Value =C  r + (1+r) t     C = Coupon payment R = yield-to-maturity F = face/par value T= number of periods If the YTM is greater than the coupon rate, the par value is greater than the bond price and it is a discount bond/bond price. If the YTM is less than the coupon rate, the par value is less than the bond price and it is a premium bond/bond price. The longer the term to maturity, the greater the interest rate risk. The lower the coupon rate, the greater the interest rate risk. C +  F − B    t  YTM = 2P+ B   3  F = face value B = bond price C = coupon T = periods The Fisher effect (1+R) = (1+r)(1+h) R ≈ r + h R = nominal rate of interest r = real rate of interest h= expected inflation rate Factors affecting required return: • Default risk premium – bond rating • Liquidity premium – bonds that have more frequent trading will generally have lower required returns • Maturity risk premium – because of interest rate risk, there is a rising maturity risk premium as term to maturity increases • Anything else that affects the risk of the cash flows to the bondholders, wi
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