Section 8
Valuing Bonds
By Boundless
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The value of a bond is obtained by discounting the bond's expected cash flows to the present using an appropriate discount rate.
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Par value is stated value or face value, with a typical bond making a repayment of par value at maturity.
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Yield to maturity is the discount rate at which the sum of all future cash flows from the bond are equal to the price of the bond.
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An inflation premium is the part of prevailing interest rates that results from lenders compensating for expected inflation.
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Nominal rate refers to the rate before adjustment for inflation; the real rate is the nominal rate minus inflation: r = R - i or, 1+r = (1+r)(1+E(r)).
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"Time to maturity" refers to the length of time before the par value of a bond must be returned to the bondholder.
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The yield to maturity is the discount rate that returns the bond's market price: YTM = [(Face value/Bond price)1/Time period]-1.
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Payment frequency can be annual, semi annual, quarterly, or monthly; the more frequently a bond makes coupon payments, the higher the bond price.
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Refunding occurs when an entity that has issued callable bonds calls those debt securities to issue new debt at a lower coupon rate.