Bond Valuation

* In another word, it’s a highly levered transaction using a fixed WACC discount rate; however the leverage is changing in fact.

The value of a bond is found as the present value of interest payments plus

Inflation erodes the purchasing power of a bond 's future cash flows. A rise in inflation will cause investors to demand higher yields to compensate for inflation rate risk. Also, prices will tend to drop because the bond will be paying interest with less purchasing power.

academic year interest rate of 3.76 percent would pay a 5,032 dollars interest over 10 years,

3. Bliss, Robert R., and Ehud I. Ronn. "Callable U.S. Treasury Bonds: Optimal Calls,        Anomalies, and Implied Volatilities." The Journal of Business 71.2 (1998): 211-52. Web.

Bonds require a minimum amount of money to purchase and a minimum length of time to hold on to the bond.

3. A 2 – year Treasury security currently earns 5.13%. Over the next 2 years, the real

(b) Coupon and principal of the Regular Treasury bonds are fixed, therefore if the inflation rate increases in the forecasting future, investor will receive the same amount of coupon and principal with less real value and purchasing power.

At what price will the bonds issue? (Do not round PV factors. Round your answer to the nearest dollar amount. Omit the "$" sign in your

The bonds have 20 years to maturity, pay interest at 9.3%, have a par value of $1,000 and are currently selling for $890.

* We assume a risk-free rate of 5.09%. This number comes from the current yield of the 30 year T-bond as shown in Exhibit 5.

2. The discount rate for this bond would be 0.70%. I started with an appropriate discount rate to derive my bond purchase price, since I would not purchase a bond without finding out ahead of time what a good price should be.

Comparing each bond’s theoretical yield and price to its actual yield and price, we find that both bonds are underpriced. However, this alone is insufficient to conclude that an arbitrage opportunity exists, since our calculated theoretical prices ignore the effects of liquidity premium. As, in this exercise, we are unable to calculate what the true liquidity premium for each bond should be, we consequently do not have a true price for each bond to compare with and ascertain whether each bond is underpriced (ie. both the theoretical and actual prices may not be the true price). Nonetheless, we have calculated the implied liquidity premium for each bond as the difference between the theoretical yield and actual yield (see Table 1 above).

The price of the bond with the little coupon will be most affected by changes in interest rates as the price of the great coupon bond. For a small coupon bond, the cash flows are weighted much more towards the maturity due to small interest payments dates. The great coupon bond has high interest

Full Price = 90% clean price + 5% coupon rate (120 days since last coupon payment/ 360 days in the year for annual bond)