Bond Fundamentals and Valuation

1. Basic Characteristics of Bonds

1. Bonds are debt instruments where the issuer borrows money from investors and promises
to pay back the principal plus interest.
2. Key bond characteristics include face value (or par value), coupon rate, coupon payment,
maturity date, and yield to maturity.
3. The relationship between coupon rate, yield to maturity and bond price is discussed.
When yield to maturity is greater than coupon rate, the bond sells at a discount. When
yield to maturity is less than coupon rate, it sells at a premium.
Relation between coupon rate and yield to maturity
1. coupon rate < yield to maturity, then the bond is selling at a discount.
2. coupon rate > yield to maturity, then the bond is selling at a premium.
3. coupon rate = yield to maturity, then the bond is selling at par.
Features affecting bond maturity
1. Indenture provisions
 The indenture is the contract between the issuer and the bondholder specifying the
issuer’s legal requirements
2. Features affecting a bond’s maturity
 Callable (call premium) (可赎回): 发行人有权在指定日期之前以预先确定的价
格(赎回价)赎回债券。赎回价通常高于债券面值,其超出部分称为赎回溢价
(Call premium)。
 Non-callable (不可赎回): 发行人无权在债券到期前赎回债券。
 Deferred call (延期赎回): 债券在发行后的初始期限内不可赎回,之后才可赎回。
 Non-refunding provision (不可再融资条款): 限制发行人在指定期限内使用较
低成本债务再融资赎回现有债券。这保护了债券持有人免受利率下降的影响。
 Sinking fund (偿债基金): 发行人定期拨款至专门账户,用于债券的分期偿还
或最终偿还。这降低了违约风险,提高了债券的信用质量。

2. Types of Bonds
1. Bonds can be classified by issuer (government, municipal, corporate), maturity (short-
term, intermediate, long-term), and other characteristics.
2. Government bonds include Treasury bills, notes and bonds in the US. Some, like TIPS,
provide inflation protection.
Treasury Indexed Bonds (TIBs)
a. To ensure the investors will receive the promised yield in real terms, the bond
principal (nominal value) and interest payments are indexed to the CPI, published
by the ABS
b. The particular CPI used is the ‘Weighted Average of Eight Capital Cities: All-
Groups Index’
c. TIB’s nominal value is adjusted every three months to reflect the inflation since
the base period
d. The interest payment is the coupon rate times the face or nominal value (Exhibit
17.4)
Semi-government Bonds
a. State or local governments issue their own bonds (semi-government bonds) in
Australia, local authority in the UK and municipals in the US
b. State run entities issue bonds on behalf of the state government and other
governmental bodies within the state
c. These state bonds pay fixed interest semi-annually

R（bank discount yield）=FV-P/FV *360/n - to calculate the expected return of the

treasury bill base on n=maturity time, e.g., 90 days bond, n=90
R (bond equivalent yield) = FV-P/P *365/n

3. Municipal bonds are issued by state/local governments and may have tax advantages.
4. Corporate bonds are issued by companies and tend to have higher yields and credit risk
than government bonds. They include asset-backed securities and international bonds.
a. All bonds are quoted on the basis of either yield or price
b. Price quotes are interpreted as a percentage of par or the dollar price per $100 of
par value
c. Variations in quotation method can arise for different bond categories such as
Treasuries, corporates, semi-governments and foreign
d. Corporate bonds are both traded in the OTC market and on the ASX
e. High-yield bonds
 Also known as speculative bonds and junk bonds
 Based on a specification that bonds rated below BBB make up the high-yield
market, that is, non-investment grade bonds
 The high-yield bond market exploded in size and activity beginning in the early
1980s
  Major owners of high-yield bonds have been mutual funds, insurance
companies and pension funds
5. International Bonds: Each country’s international bond market has two components
a. Foreign bonds - issues sold primarily in one country and currency by a borrower
of a different nationality, e.g., Kangaroo bonds
b. Eurobonds - bonds underwritten by international bond syndicates and sold in
several national markets.
6. Other types include zero coupon bonds, callable bonds, putable bonds and perpetual
bonds.
 Zero-Coupon Bonds
Pay no coupons prior to maturity.
Sold to investors at a discount from face value.
The difference between the initial price and the face value of the bond is the
return to the investor.
Pay the bond’s face value at maturity.

 Perpetual Bonds
No maturity date.
Pay a stated coupon at periodic intervals.

 Coupon Bonds
Conventional Bonds
Pay a stated coupon at periodic intervals prior to maturity.
Pay the bond’s face value at maturity.
Callable bonds give the issuer the right to "call" or redeem the bond before
maturity. This typically happens when interest rates fall, allowing the issuer to
refinance at a lower rate. Callable bonds are priced at a premium to straight bonds
to compensate investors for this risk.
"Callable bond" 是一种债券，发行者（通常是公司或政府）在特定时期内享
有权利，在此期间内可以提前赎回债券。
通常情况下，当利率下降或者市场环境有利于发行者时，发行者会行使这种
权利。这样他们可以重新发行债券，以更低的利率融资，从而降低成本。
对于投资者来说，callable bond 的一个缺点是，如果债券被提前赎回，他们
可能无法继续获得较高的利息支付，而需要重新投资资金，但可能面临着更
低的利率。
Putable bonds give the investor the right to "put" or sell the bond back to the
issuer before maturity. This provides protection against rising interest rates.
Putable bonds are priced at a discount to straight bonds.
 与 callable bond 相反，"Putable bond" 是投资者有权利在特定时期内将其持
有的债券出售给发行者的债券。
这种债券通常在市场环境不稳定或者投资者担心发行者的信用质量时较为流
行。投资者可以在债券的到期日之前将债券出售，这样可以减少风险。
但是，通常这种权利的代价是投资者需要接受较低的利率，因为这种灵活性
会增加发行者的风险。

3. Bond Pricing
1. Bond pricing concepts like quoted price, bid-ask spread, and yield to maturity
calculations are covered using a Bloomberg terminal screenshot as an example.
2. For Treasury bills, the discount yield and bond equivalent yield calculations are
discussed.
3. The lecture demonstrates how to calculate the price of a bond using the present value
formula, considering the coupon payments and face value.
4. It shows how to use an online financial calculator and Excel's PV function to simplify the
calculations.
5. The lecturer also explains how to calculate the price of a bond between coupon dates,
taking into account the reduced number of remaining coupon payments.

Online Financial Calculator: https://www.calculator.net/finance-calculator.html

评估一支债券的价值通常需要进行一系列步骤：

1. 确定债券的基本特征：

Identify the basic characteristics of the bond, including its type (such as fixed-rate (固定
利率), floating-rate (浮动利率), callable (可赎回), convertible (可转换), etc.), face value
(or par value), coupon rate, coupon payment, maturity date, and other relevant details.

2. 计算现金流：

Calculate the cash flows of the bond over its remaining life, including interest payments
and the repayment of principal at maturity.

3. 确定折现率：

Determine an appropriate discount rate, typically using the market interest rate or a
similar bond's yield to maturity, to discount the future cash flows. The discount rate
should reflect the bond's risk profile and prevailing market conditions.
 4. 计算现值：

Use the determined discount rate to discount the future cash flows back to their present
value, thereby determining the bond's current price.

5. 评估风险：

Assess the bond's risk factors, including credit risk, market risk, liquidity risk, etc., which
will influence investor demand and, consequently, the bond's price.

6. 进行比较分析：

Conduct comparative analysis against similar bonds to determine relative value. This may
involve comparing yield to maturity, current yield, spreads, and other relevant metrics.

7. 调整估值：

Adjust the valuation based on the assessment results and market conditions. This may
involve considering factors such as market expectations, macroeconomic conditions, etc.

8. 制定投资决策：

Make investment decisions based on the assessment of the bond's value, including
buying, holding, or selling the bond.

4. Determinants of Price Volatility for Bonds

1. Factors affecting bond price volatility include interest rate risk, credit risk, liquidity risk,
and maturity. Longer maturity bonds have higher price sensitivity to interest rate changes.
2. The lecture discusses the factors that influence bond price volatility, including the coupon
rate, term to maturity, and market interest rates.
3. Five important relationships
a. Bond prices move inversely to bond yields
b. For a given change in yields, longer maturity bonds post larger price changes, thus
bond price volatility is directly related to maturity
c. Price volatility increases at a diminishing rate as term to maturity increases
d. Price movements resulting from equal absolute increases or decreases in yield are
not symmetrical
e. Higher coupon issues show smaller percentage price fluctuation for a given
change in yield, thus bond price volatility is inversely related to coupon
4. It also notes that longer-term bonds and lower coupon bonds have greater price sensitivity
to interest rate changes.
 a. The maturity effect: The longer-maturity bond experienced the greater price
volatility. Price volatility increased at a decreasing rate with maturity, See PPT 3.1
Page 50
b. The coupon effect: Exhibit 18.11 shows that the inverse relationship between
coupon rate and price volatility, see PPT 3.1 Page 51

The price-yield curve

The price-yield curve: There exists a inverse relationship between bond price and bond yield
to maturity – its required rate of return
If yield < coupon rate, bond will be priced at a premium to its par value
If yield > coupon rate, bond will be priced at a discount to its par value
Price-yield relationship is convex (not a straight line)

5. Bond Yield
The lecturer discusses different types of bond yields, including current yield, promised yield, and
realized yield.
1. Current yield (coupon rate) is the coupon payment divided by the bond's market price.
2. Running yield is the coupon as a percentage of current price of bond
3. Yield to maturity is the expected return if the bond is held until maturity.
4. Yield to call is the expected return if the bond is called by the issuer before maturity.
5. Realized yield or horizon yield takes into account the reinvestment rate of coupon
payments and the bond's selling price before maturity.
The realized yield takes into account the future value of the coupon payments at the reinvestment
rate and the bond's selling price at the end of the holding period.

6. Determinants of Bond Yields

1. Bond yields are driven by factors like risk-free rates, credit risk premiums, liquidity
premiums and maturity premiums. Longer maturity and lower credit quality bonds tend
to have higher yields.
2. Bond yields are a function of the real or risk-free rate, inflation, and risk premium. Risk
premium is determined by bond characteristics such as credit quality, term to maturity,
indenture provisions, and whether the bond is foreign or domestic.
Credit ratings, ranging from investment grade to speculative and default, impact bond yields.
The term structure of interest rates, represented by the yield curve, can be rising, flat, or
declining.
Theories such as the expectation hypothesis, liquidity preference theory, and segmented market
hypothesis attempt to explain the shape of the yield curve.
7.Valuation between Coupon Dates

8.Bond Valuation using Spot Rates