Learning Module

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 Definitions

 Par or Face Value -

 The amount of money that is paid to the bondholders at maturity. For
most bonds this amount is $1,000. It also generally represents the
amount of money borrowed by the bond issuer.

 Coupon Rate -
 The coupon rate, which is generally fixed, determines the periodic
coupon or interest payments. It is expressed as a percentage of the
bond's face value. It also represents the interest cost of the bond to the
issuer.

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 Definitions

 Coupon Payments -
 The coupon payments represent the periodic interest payments from
the bond issuer to the bondholder. The annual coupon payment is
calculated by multiplying the coupon rate by the bond's face value.
Since most bonds pay interest semiannually, generally one half of the
annual coupon is paid to the bondholders every six months.

 Maturity Date -
 The maturity date represents the date on which the bond matures, i.e.,
the date on which the face value is repaid. The last coupon payment is
also paid on the maturity date.

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 Definitions

 Original Maturity -
 The time from when the bond was issued until its maturity date.

 Remaining Maturity -
 The time currently remaining until the maturity date.

 Call Date -
 For bonds which are callable, i.e., bonds which can be redeemed by the
issuer prior to maturity, the call date represents the earliest date at
which the bond can be called.

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 Definitions

 Call Price -
 The amount of money the issuer has to pay to call a callable bond
(there is a premium for calling the bond early). When a bond first
becomes callable, i.e., on the call date, the call price is often set to
equal the face value plus one year's interest.

 Required Return -
 The rate of return that investors currently require on a bond.

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 Definitions

 Yield to Maturity -
 The rate of return that an investor would earn if he bought the bond
at its current market price and held it until maturity. Alternatively, it
represents the discount rate which equates the discounted value of a
bond's future cash flows to its current market price.

 Yield to Call -
 The rate of return that an investor would earn if he bought a callable
bond at its current market price and held it until the call date given
that the bond was called on the call date.

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Bond Valuation

 Bonds are valued using time value of money

concepts.

 Their coupon, or interest, payments are treated

like an equal cash flow stream (annuity).

 Their face value is treated like a lump sum.

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 Example
 Assume Hunter buys a 10-year bond from the KLM
corporation on January 1, 2003. The bond has a face value of
$1000 and pays an annual 10% coupon. The current market
rate of return is 12%. Calculate the price of this bond today.

1. Draw a timeline
$1000
+
$100 $100 $100 $100 $100
$100 $100 $100 $100 $100

?
? 8
Example
2. First, find the value of the coupon stream
 Remember to follow the same approach you use in
time value of money calculations.
 You can find the PV of a cash flow stream
 PV = $100/(1+.12)1 + $100/(1+.12)2 + $100/(1+.12)3 +
$100/(1+.12)4 + $100/(1+.12)5 + $100/(1+.12)6 + $100/(1+.12)7
+ $100/(1+.12)8 + $100/(1+.12)9+ $100/(1+.12)10
 Or, you can find the PV of an annuity
 PVA = $100 * {[1-(1+.12)-10]/.12}

 PV = $565.02

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 Example

3. Find the PV of the face value

 PV = CFt / (1+r)t
 PV = $1000/ (1+.12)10
 PV = $321.97
4. Add the two values together to get the total PV
 $565.02 + $321.97 = $886.99
 Alternatively, on your calculator
 PMT = 100
FV = 1000
n = 10
i = 12
PV = ?
 Note that if the payments had been semiannual,
PMT=50, FV=1000, n=20, i=6, PV=?=$885.30.

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Realized Return

 Sometimes you will be asked to find the realized rate of

return for a bond.

 This is the return that the investor actually realized from

holding a bond.

 Using time value of money concepts, you are solving for

the required rate of return instead of the value of the
bond.

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 Example
 Doug purchased a bond for $800 5-years ago and he sold the
bond today for $1200. The bond paid an annual 10% coupon.
What is his realized rate of return?
n
 PV = [CFt / (1+r)t]
t=0

 $800 = [$100/(1+r) + $100/(1+r)2 + $100/(1+r)3 + $100/(1+r)4 +

$100/(1+r)5] + [$1200/(1+r)5]
 To solve, you need use a “trail and error” approach. You plug in
numbers until you find the rate of return that solves the
equation.
 The realized rate of return on this bond is 19.31%.

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 Example

 This is much easier to find using a financial calculator:

 n=5
PV = -800
FV = 1200
PMT = 100
i = ?, this is the realized rate of return on this bond
 Note that if the payments had been semiannual,
n=10, PV=-800, FV=1200, PMT=50, i=?=9.47%. Thus, the
realized return would have been 2 * 9.47% = 18.94%.

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Market Analysis

 Fundamental Analysis
 Technical Analysis

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 Fundamental Analysis
 A method of evaluating a security that
entails attempting to measure its intrinsic value
by examining related economic, financial and
other qualitative and quantitative factors.
 Fundamental analysts attempt to study
everything that can affect the security's value,
including macroeconomic factors (like the overall
economy and industry conditions) and company-
specific factors (like financial condition and
management). 

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Fundamental Analysis

 Top to bottom Approach

 Macroeconomic Analysis
 Industry Analysis
 Company Analysis
 Bottom Up Approach
 Company Analysis
 Industry Analysis
 Macroeconomic Analysis

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Macroeconomic factors

 Inflation
 Interest Rate
 Industrial Production
 Savings
 Exchange rate
 FDI

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Macroeconomic factors

 FPI
 Money Supply
 Oil Prices
 Consumption Index
 Per Capita Income
 Taxes

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Technical Analysis

 It involves examination of prices or volume to

explore the trends so that these can be used
for investment decision making.

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Technical Analysis

 A method of evaluating securities by

analyzing statistics generated by market
activity, such as past prices and volume.
Technical analysts do not attempt to measure
a security's intrinsic value, but instead use
charts and other tools to identify patterns
that can suggest future activity.

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Technical Analysis
(Assumptions)
 Prices are determined on basis of supply and
demand.
 Prices are affected by rational and irrational
factors.
 Prices move in trends.
 Trends changes due to shift in supply and
demand.

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Criticism

 EMH
 Trading rule instability

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Types of T.Analyst

 Contrary opinion rule

 Follow the smart money
 Other environmental factors
 Price and volume based measures

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Contrary opinion rule

 Cash position of mutual fund

 Investment Advisory opinion
 Credit balances in brokerage account
 Put/Call ratio
 Future Trade bullish on stock index future

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Follow the smart money

 Confidence Index
Avg return of Top10 rated bonds
Avg return of 40DJIA bond Index
 Investment Advisory opinion
 Credit balances in brokerage account
 Put/Call ratio
 Future Trade bullish on stock index future

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Other environmental factors

 Breadth of Market
Advances
Declines
 Stock Price above 200 days moving Average
 Short Interest Ratio

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