ADMS 3530 Winter 2012 – Professor Lois King
Lecture 4 – Valuing Bonds – Jan 24
4.1 Introduction to Bonds
− What is a bond?
o A bond is a debt instrument issued for a period of more than one year with the
purpose of raising money by borrowing.
o Corporations, governments and other institutions sell bonds.
o Generally, a bond is a promise to replay the principal along with interest
(coupons) on a specified date (maturity).
− Why should we know how to value bonds?
o Financial managers need to know in case their firm needs to raise funds via a
o Individuals should know for personal investment reasons.
4.1 Description of Bond Terms
− ‘Par value’ of a bond, is the payment a holder will receive at the maturity of the bond. It
almost always is $1,000 and it is also referred to as ‘face value’, ‘maturity value’ or
− ‘Maturity date’ is the date the loan will be paid off and is usually 5, 10, 20 years from
− ‘Coupons’ are the fixed interest payments that issuer promises to make to bondholders.
− ‘Coupon rate’ is usually expressed as a percentage of par values.
− ‘Discount rate’ is the current interest rate that the market is demanding of similar
o It is also referred to as:
The market interest rate (or interest rate)
Its yield to maturity.
The opportunity cost of funds.
4.2 Valuation of Bonds
− Present value = the discounted value of each future cash flow.
− Current market price of a bond = PV of a bond.
o Price of a bond = PV (coupons) + PV (face value)
4.3 Bond Prices & Market Interest Rates − Bond prices are inversely related to market interest rates:
o That is, when market rates (‘r) increase, bond prices decrease and vice versa.
− Bond prices are inversely related to market interest rates:
o If coupon rate = market interest rate, then bond price =$1000
Bond sells at ‘par’
o If coupon rate > market interest rate, then bond price > $1000
Bonds sells at a ‘premium’
o If coupon rate