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1、Chapter 10 The Bond Market Purpose of the Capital Market Capital Market Participants Capital Market Trading Organized Securities Exchanges Over-the-Counter Markets Types of Bonds Treasury Notes and Bonds Treasury Bond Interest Rates Treasury Inflation Protected Securities(TIPS)Treasury Strips Agency
2、 Bonds Municipal Bonds Risk in the Municipal Bond Market Corporate Bonds Characteristics of Corporate Bonds Types of Corporate Bonds Financial Guarantees for Bonds Current Yield Calculation Current Yield Finding the Value of Coupon Bonds Finding the Price of Semiannual Bonds Investing in Bonds Chapt
3、er 10 examines securities that have an original maturity that is greater than one year.These types of securities are traded in capital markets and the best known securities are stocks and bonds.This chapter focuses on the characteristics of the bonds while the next chapter extends the capital market
4、 discussion to stocks.Capital markets are used for long term financing and investments.The beginning of the chapter discusses the purpose of and the participants in the capital market so students will get a better understanding of the topic when it is discussed in depth in later sections.We explore
5、two categories of capital markets:bonds and stocks.Show the students Table 1 because it gives a clear understanding of the different types of Treasury securities.Treasury securities are free of default risk,but not risk-free,and have a very low interest rate.Bonds issued by local,county,and state go
6、vernments are municipal bonds and are used to finance public interest projects.Point out to students that municipal bonds are not free of default.Corporate bonds usually have a face value of$1,000 and can be redeemed at anytime.52 Mishkin/Eakins Financial Markets and Institutions,Sixth Edition The c
7、hapter concludes by showing how to compute the value of bonds.An example focuses specifically on valuing semiannual bonds.This valuation model can be used to show that interest-rate risk will affect the wealth of investors in bonds.1.Investors use capital markets for long-term investment purposes.Th
8、ey use money markets,which have lower yields,primarily for temporary or transaction purposes.2.The primary capital market securities are stocks and bonds.Most of these are purchased and owned by households.3.The primary market is for securities being issued for the very first time,and the issuer rec
9、eives the funds paid for the security.The secondary market is for securities that have been issued previously but are being traded among investors.4.The par value is the amount the issuer will pay the holder when the bond matures.The coupon interest rate is multiplied times the par value to determin
10、e the interest payment the issuer must make each year.The maturity date is when the issuer must pay the holder the par value.5.Treasury bills mature in less than 1 year,Treasury notes mature in 1 to 10 years,and Treasury bonds mature in 10 to 30 years.6.The risk that a bonds price will change due to
11、 changes in market interest rates is call interest rate risk.7.Agencies that issue securities include Ginnie Mae(formerly the Government National Mortgage Association),the Federal Housing Administration,the Veterans Administration,the Federal National Mortgage Association,and the Student Loan Market
12、ing Association.The first four fund mortgage loans and the last funds college student loans.8.Firms like having the flexibility to adjust their capital structure by paying off debt they no longer need.They also need to pay off debt to remove restrictive covenants.Call provisions permit both these ac
13、tions at the issuers discretion.9.A sinking fund contains funds set aside by the issuer of a bond to pay for the redemption of the bond when it matures.Because a sinking fund increases the likelihood that a firm will have the funds to pay off the bonds as required,investors like the feature.As a res
14、ult,interest rates are lower on securities with sinking funds.10.The list of terms of a bond is known as the indenture.11.Capital market securities may be sold in a public offering or in a private placement.In a public offering,investment bankers register the security with the SEC and market it thro
15、ugh a network of brokerage houses.In a private placement,the firm or an investment banker sells the securities to a very limited number of investors,who each buy a large quantity.Chapter 10 The Bond Market 53 1.A bond pays$80 per year in interest(8%coupon).The bond has 5 years before it matures at w
16、hich time it will pay$1,000.Assuming a discount rate of 10%,what should be the price of the bond(Review Chapter 3)?Solution:$924.18 2.A zero coupon bond has a par value of$1,000 and matures in 20 years.Investors require a 10%annual return on these bonds.For what price should the bond sell?(note,zero
17、 coupon bonds do not pay any interest)(Review Chapter 3)?Solution:$148.64 3.Consider the two bonds described below:Bond A Bond B Maturity 15 yrs 20 yrs Coupon Rate (Paid semiannually)10%6%Par Value$1,000$1,000 a.If both bonds had a required return of 8%,what would the bonds prices be?b.Describe what
18、 it means if a bond sells at a discount,a premium,and at its face amount (par value).Are these two bonds selling at a discount,premium,or par?c.If the required return on the two bonds rose to 10%,what would the bonds prices be?Solution:a.Bond A$1,172.92 Bond B$802.07 b.Bond A is selling at a premium
19、 Bond B is selling at a discount c.Bond A$1,000 Bond B$656.82 4.A 2-year$1,000 par zero-coupon bond is currently priced at$819.00.A 2-year$1,000 annuity is currently priced at$1,712.52.If you want to invest$10,000 in one of the two securities,which is a better buy?You can assume a.the pure expectati
20、ons theory of interest rates holds,b.neither bond has any default risk,maturity premium,or liquidity premium,and c.you can purchase partial bonds.Solution:With PV$819,FV$1,000,PMT 0 and N 2,the yield to maturity on the two-year zero-coupon bonds is 10.5%for the two-year annuities,PV$1,712.52,PMT 0,F
21、V$2,000 and N 2 gives a yield to maturity of 8.07%.The zero-coupon bonds are the better buy.54 Mishkin/Eakins Financial Markets and Institutions,Sixth Edition 5.Consider the following cash flows.All market interest rates are 12%.Year 0 1 2 3 4 Cash Flow 160 170 180 230 a.What price would you pay for
22、 these cash flows?What total wealth do you expect after 2 years if you sell the rights to the remaining cash flows?Assume interest rates remain constant.b.What is the duration of these cash flows?c.Immediately after buying these cash flows,all market interest rates drop to 11%.What is the impact on
23、your total wealth after 2 years?Solution:a.234160170180230Price552.671.121.121.121.12 1.5551.5180230Expected Wealth160(1.12)170(1.12)$733.691.121.12 b.234160170180230(1)(2)(3)1.121.121.121.12Duration2.50552.67 c.Expected Wealth 1.5.5.51.5180230160(1.11)170(1.11)$733.741.111.11 Since you are holding
24、the cash flows for their duration,you are essentially immunized from interest rate changes(in this simplistic example).6.The yield on a corporate bond is 10%and it is currently selling at par.The marginal tax rate is 20%.A par value municipal bond with a coupon rate of 8.50%is available.Which securi
25、ty is a better buy?Solution:The equivalent tax-free rate taxable interest rate (1 marginal tax rate).In this case,0.10 (1 0.20)8%.The corporate bond offers a lower after-tax yield given the marginal tax rate,so the municipal bond is a better buy.7.If the municipal bond rate is 4.25%and the corporate
26、 bond rate is 6.25%,what is the marginal tax rate assuming investors are indifferent between the two bonds?Solution:The equivalent tax-free rate taxable interest rate (1 marginal tax rate).In this case,0.0425 0.0625 (1 X),or X 32%.8.M&E Inc.has an outstanding convertible bond.The bond can be convert
27、ed into 20 shares of common equity(currently trading at$52/share).The bond has 5 years of remaining maturity,a$1,000 par value,and a 6%annual coupon.M&Es straight debt is currently trading to yield 5%.What is the minimum price of the bond?Solution:The price must exceed the straight bond value or the
28、 value of conversion(you will see why in the next question).If converted,the debt is worth$52 20$1,040.Assuming a 5%YTM is correct,the price of straight debt is computed as:PMT 60;N 5;FV 1000;I 5 Compute PV;PV 1,043.29 The bond must be trading for at least 1,043.29.Chapter 10 The Bond Market 55 9.As
29、sume the debt in the previous question is trading at 1,035.How can you earn a riskless profit from this situation(arbitrage)?Solution:a.Short 20 shares of M&E at$52/share.Cash$1,0470*b.Purchase a convertible bond.($1,0.35)$5 c.Convert the bond to shares,and use to close short position.Assuming these
30、 transactions are completed simultaneously,you make a riskless profit of$5.*Typically,small investors cannot short stock and have use of the proceedsthe broker retains it as collateral.So,this doesnt quite work.But the idea is correct.10.A 10-year,1,000 par value bond with a 5%annual coupon is tradi
31、ng to yield 6%.What is the current yield?Solution:The current price of the bond is computed as follows:PMT 50;N 10;FV 1000;I 6 Compute PV;PV 926.40 The current yield 50/926.40 5.4%11.A$1,000 par bond with an annual coupon has only 1 year until maturity.Its current yield is 6.713%and its yield to mat
32、urity is 10%.What is the price of the bond?Solution:a.CY 0.06713 Coupon/Price,or Coupon 0.06713 Price b.Price (Coupon 1000)/1.10.Substituting from(1),Price (0.06713 Price 1000)/1.10 Solve for Price,Price$968.17 12.A 1-year discount bond with a face value of$1,000 was purchased for$900.What is the yi
33、eld to maturity?What is the yield on a discount basis?Solution:900 1000/(1 YTM),or YTM 11.11%YDB (1000 900)/1000 (360/365)9.86%13.A 7-year,$1,000 par bond has an 8%annual coupon and is currently yielding 7.5%.The bond can be called in 2 years at a call price of$1,010.What is the bond yielding,assumi
34、ng it will be called(known as the yield to call)?Solution:The current price of the bond is computed as follows:PMT 80;N 7;FV 1000;I 7.5 Compute PV;PV 1,026.48 Using this,the yield to call is calculated as follows:PMT 80;N 2;FV 1010;PV 1,026.48 Compute I;I 7.018%56 Mishkin/Eakins Financial Markets an
35、d Institutions,Sixth Edition 14.A 20-year$1,000 par value bond has a 7%annual coupon.The bond is callable after the 10th year for a call premium of$1,025.If the bond is trading with a yield to call of 6.25%,the bonds yield to maturity is what?Solution:The current price of the bond is computed using
36、the yield to call as follows:PMT 70;N 10;FV 1025;I 6.25 Compute PV;PV 1,068.19 Using this,the yield to maturity is calculated as follows:PMT 70;N 20;FV 1000;PV 1,068.19 Compute I;I 6.39%15.A 10-year$1,000 par value bond has a 9%semi-annual coupon and a nominal yield to maturity of 8.8%.What is the p
37、rice of the bond?Solution:The price of the bond is computed as follows:PMT 45;N 20;FV 1000;I 8.8 Compute PV;PV 1,013.12 16.Your company owns the following bonds:Bond Market Value Duration A$13 million 2 B$18 million 4 C$20 million 3 If general interest rates rise from 8%to 8.5%,what is the approximate change in the value of the portfolio?Solution:Portfolio duration 2 (13/51)4 (18/51)3 (20/51)3.09 Value Duration (i/(1 i)Original Value Value 3.09 (0.005/1.08)$51 million$729,583