The document discusses different types of bonds such as fixed rate bonds, floating rate bonds, and inflation-linked bonds. It defines key bond terms like coupon rate, maturity value, and discount rate. Examples are provided to illustrate how to calculate the coupon rate of a bond and value bonds using present value calculations.

1. Lesson Plan What’s A Bond? Types of Bonds Bond Valuation Techniques The Bangladeshi Bond Market Problem Set A bond is a long-term debt instrument issued by a corporation or a government. It is a fixed-income security. A bond is a formal contract to repay borrowed money with interest at fixed intervals. A bond provides the borrower with external funds to: finance long term investments (for corporations) finance current expenditures (for municipal, state or national governments). What’s a bond?

2. Difference between stocks and bonds Shares of stock Bond Equity stake in the firm Creditor stake in the firm [i.e. owners] [.i.e. lenders] Undefined term Defined term (maturity) (outstanding indefinitely) Types of bonds A non-zero coupon-paying bond is a coupon-paying bond with a finite life. A zero-coupon bond is a bond that pays no interest but sells at a deep discount from face value. A perpetual bond is a bond that never matures. It has an infinite life.

3. Types of bonds A fixed rate bond is a bond whose coupon rate remains constant throughout the life of the bond. A floating rate bond is a bond with a variable coupon that is linked to a reference rate of interest, such as the LIBOR. [LIBOR + 20 b.p.] An inflation-linked bond is a bond whose coupon payments and principal are indexed to inflation. Gilts in the UK TIPS in the US A Municipal bond (or muni) is a bond issued by a municipality, city, state or their agencies and is usually tax exempt. A lottery bond is a bond with coupon payments like fixed-rate bonds, but the issuer will redeem randomly selected individual bonds for a higher value than the bond’s face value. An asset-backed security (e.g. CDOs, CMOs, MBSs) is a bond whose interest and principal payments are backed by underlying cash flows from other assets.

4. The maturity value Coupon rate = Annual coupon payments (CP) Maturity value (MV) For example: Annual coupon payments = $80 Face value = $1,000 Coupon rate = $80/$1,000 = 0.08 = 8% The maturity value (MV) [or face value] of a bond is the stated value. In the case of a U.S. bond, the MV is usually $1,000. In the case of a Bangladeshi prize bond, the MV is usually 100 Taka. Coupon rate The coupon rate [or coupon yield] of a bond is the stated rate of interest.

5. Sample problem #1 If the annual coupon payments are $70 and the face value of a bond is $1,000, what is its coupon rate? Annual coupon payments = $70 Face value = $1,000 Coupon rate = $70/$1,000 = 0.07 = 7% Coupon rate = Annual coupon payments (CP) Maturity value (MV) Sample problem #2 If the annual coupon payments are $100 and the face value of a bond is $1,000, what is its coupon rate? Annual coupon payments (CP) Maturity value (MV) Coupon rate = Annual coupon payments = $100 Face value = $1,000 Coupon rate = $100/$1,000 = 0.10 = 10%

6. The discount rate The discount rate [or capitalization rate] of a bond is dependent on the risk of the bond. The discount rate (k d ) is composed of the risk-free rate plus a premium for risk. Bond valuation Bond value = PV of coupons + PV of MV Bond value = PV annuity + PV of lump sum Remember: as interest rates increase, the PVs decrease. So, as interest rates increase, bond prices decrease. V = CP (PVIFA k d , n ) + MV (PVIF k d , n ) A bond has a $1,000 face value and provides an 8% annual coupon for 30 years. The appropriate discount rate is 10% . What is the value of the bond?

7. Bond valuation A bond has a $ 1,000 face value and provides an 8% annual coupon for 30 years. The appropriate discount rate is 10% . What is the value of the bond? V = CP (PVIFA 10% , 30 ) + MV (PVIF 10% , 30 ) = $80 (9.427) + $1,000 (0.057) = $754.16 + 57.00 = $811.16 Sample problem #1 A bond has a $ 1,000 face value and provides a 6% annual coupon for 20 years. The appropriate discount rate is 6% . What is the value of the bond? V = CP (PVIFA 6% , 20 ) + MV (PVIF 6% , 20 ) = $60 (11.4699) + $1,000 (0.3118) = $688.19 + 311.80 = $999.99