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Bond Pricing And Analysis

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Bond Pricing And Analysis

  1. 1. BOND ANALYSIS
  2. 2. CAPITALIZATION OF INCOME METHOD <ul><li>PROMISED YIELD-TO-MATURITY </li></ul><ul><ul><li>In equation form </li></ul></ul><ul><ul><li>where P=the current market price of bond </li></ul></ul><ul><ul><li>n=the number of years to maturity </li></ul></ul><ul><ul><li>C t =the annual coupon payment </li></ul></ul><ul><ul><li>y=the prevailing yield to maturity </li></ul></ul>
  3. 3. CAPITALIZATION OF INCOME METHOD <ul><li>INTRINSIC VALUE </li></ul><ul><ul><li>In equation form </li></ul></ul>
  4. 4. CAPITALIZATION OF INCOME METHOD <ul><li>SOLVING FOR V, </li></ul><ul><ul><li>Given the current market price (P), the investment decision is </li></ul></ul><ul><ul><ul><li>if V is the intrinsic value and </li></ul></ul></ul><ul><ul><ul><li>V>P buy the bond </li></ul></ul></ul><ul><ul><ul><li>V<P don’t buy </li></ul></ul></ul>
  5. 5. CAPITALIZATION OF INCOME METHOD <ul><li>ALTERNATIVELY </li></ul><ul><ul><li>SOLVING FOR y * </li></ul></ul><ul><ul><li> y * >y bond overprice </li></ul></ul><ul><ul><li> y * <y bond underpriced </li></ul></ul>
  6. 6. BOND ATTRIBUTES <ul><li>SIX ATTRIBUTES that affect a bond’s value </li></ul><ul><ul><li>LENGTH OF TIME TO MATURITY </li></ul></ul><ul><ul><li>COUPON RATE </li></ul></ul><ul><ul><li>CALL PROVISIONS </li></ul></ul><ul><ul><li>TAX STATUS </li></ul></ul><ul><ul><li>MARKETABILITY </li></ul></ul><ul><ul><li>LIKELIHOOD OF DEFAULT </li></ul></ul>
  7. 7. LENGTH OF TIME TO MATURITY <ul><li>COUPON RATE AND LENGTH TO MATURITY </li></ul><ul><ul><li>these attributes determine size and timing of cash flow </li></ul></ul><ul><ul><li>yield-to-maturity </li></ul></ul>
  8. 8. TAX STRUCTURE <ul><li>TAX STRUCTURE </li></ul><ul><ul><li>Taxation affects bond prices and yields </li></ul></ul><ul><ul><ul><li>low-coupon bonds selling at a discount provide return in </li></ul></ul></ul><ul><ul><ul><ul><li>coupon payments </li></ul></ul></ul></ul><ul><ul><ul><ul><li>gains from price appreciations </li></ul></ul></ul></ul><ul><ul><ul><li>taxes on appreciations may be deferred until bond sale or maturity </li></ul></ul></ul><ul><ul><ul><li>discount bonds have a tax advantage </li></ul></ul></ul>
  9. 9. TAX STRUCTURE <ul><li>TAX STRUCTURE </li></ul><ul><ul><li>Taxation affects bond prices and yields </li></ul></ul><ul><ul><ul><li>because of tax effect, discount bonds should have a slightly lower before-tax yield </li></ul></ul></ul><ul><ul><ul><li>low-coupon bonds will have a slightly higher intrinsic value </li></ul></ul></ul>
  10. 10. MARKETABILITY <ul><li>MARKETABILITY </li></ul><ul><ul><li>refers to the ability of the investor to resell </li></ul></ul>
  11. 11. MARKETABILITY <ul><li>MARKETABILITY </li></ul><ul><ul><li>bid-ask spread is one indicator of marketability </li></ul></ul><ul><ul><ul><li>the higher the spread, the less marketable </li></ul></ul></ul><ul><ul><ul><li>the lower the spread, the more marketable </li></ul></ul></ul><ul><ul><li>bonds that are actively traded should have a lower YTM and a higher V </li></ul></ul>
  12. 12. MARKETABILITY <ul><li>MARKETABILITY </li></ul><ul><ul><li>bonds that are actively traded should have a lower YTM and a higher V </li></ul></ul>
  13. 13. LIKELIHOOD OF DEFAULT <ul><li>LIKELILHOOD OF DEFAULT </li></ul><ul><ul><li>Bond ratings provided by professional services. </li></ul></ul>
  14. 14. LIKELIHOOD OF DEFAULT <ul><li>LIKELILHOOD OF DEFAULT </li></ul><ul><ul><li>Two most famous include </li></ul></ul><ul><ul><ul><li>Moody’s Investors Services, Inc. </li></ul></ul></ul><ul><ul><ul><li>Standard & Poor’s Corporate ratings </li></ul></ul></ul>
  15. 15. LIKELIHOOD OF DEFAULT <ul><li>LIKELIHOOD OF DEFAULT </li></ul><ul><ul><li>Categories </li></ul></ul><ul><ul><ul><li>investment grade usually the bonds in the top four ratings </li></ul></ul></ul><ul><ul><ul><li>speculative </li></ul></ul></ul><ul><ul><ul><li>often called junk bonds </li></ul></ul></ul>
  16. 16. LIKELIHOOD OF DEFAULT <ul><li>LIKELIHOOD OF DEFAULT </li></ul><ul><ul><li>Bond ratings provided by professional services. </li></ul></ul><ul><ul><ul><li>better ratings are generally associated with </li></ul></ul></ul><ul><ul><ul><ul><li>larger financial leverage </li></ul></ul></ul></ul><ul><ul><ul><ul><li>larger firm size </li></ul></ul></ul></ul><ul><ul><ul><ul><li>larger and steadier profits </li></ul></ul></ul></ul><ul><ul><ul><ul><li>large cash flows </li></ul></ul></ul></ul><ul><ul><ul><ul><li>lack of subordination to other debt series </li></ul></ul></ul></ul>

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