Key Features of a Bond Essay

Words: 1553
Pages: 7

A. What are the key features of a bond?

answer: if possible, begin this lecture by showing students an actual bond certificate. We show a real coupon bond with physical coupons. These can no longer be issued--it is too easy to evade taxes, especially estate taxes, with bearer bonds. All bonds today must be registered, and registered bonds don't have physical coupons.

1. Par or face value. We generally assume a $1,000 par value, but par can be anything, and often $5,000 or more is used. With registered bonds, which is what are issued today, if you bought $50,000 worth, that amount would appear on the certificate.

2. Coupon rate. The dollar coupon is the "rent" on the money borrowed, which is generally the par value of the
…show more content…
. pv4 pv5c pv5cp 1,135.90 = sum of pvs

The easiest way to find the ytc on this bond is to input values into your calculator: n = 10; pv = -1135.90; pmt = 50; and fv = 1050, which is the par value plus a call premium of $50; and then press the k = i button to find i = 3.765%. However, this is the 6-month rate, so we would find the nominal rate on the bond as follows:

Knom = 2(3.765%) = 7.5301% ≈ 7.5%.

This 7.5% is the rate brokers would quote if you asked about buying the bond.
You could also calculate the ear on the bond:

Ear = (1.03765)2 - 1 = 7.672%.

Usually, people in the bond business just talk about nominal rates, which is ok so long as all the bonds being compared are on a semiannual payment basis. When you start making comparisons among investments with different payment patterns, though, it is important to convert to ears.

K. 2. If you bought this bond, do you think you would be more likely to earn the ytm or the ytc? Why?

Answer: since the coupon rate is 10% versus ytc = kd = 7.53%, it would pay the company to call the bond, get rid of the obligation to pay $100 per year in interest, and sell replacement bonds whose interest would be only $75.30 per year. Therefore, if interest rates