Chapter 14 – Bond Prices and Yields
14-1
CHAPTER FOURTEEN
BOND PRICES AND YIELDS
CHAPTER OVERVIEW
This chapter presents first discussion of the various types of bonds, bond characteristics, determinants of
bond risk, bond ratings, and the pricing and yield calculations of various types of bonds.
LEARNING OBJECTIVES
After studying this chapter, the student should have a thorough understanding of the pricing,
PRESENTATION OF MATERIAL
14.1 Bond Characteristics
The key provisions for a bond are outlined in the indenture of the bond. The major issuers of bonds are
listed along with a few examples of innovative bond structures. Note that prices quoted in the financial
pages do not contain accrued interest, so it will be helpful to walk students through this calculation. Most
14.2 Bond Pricing
The bond pricing equation and a sample calculation are presented here. It is important that students
14.3 Bond Yields
Yield to maturity is the interest rate that makes the present value of the bond’s payments equal to its price.
Chapter 14 – Bond Prices and Yields
financial press. It only considers the income and current market price. It does not consider capital gains
or losses that are implicit in the yield to maturity. Yield to call is also presented. Instructors should guide
14.4 Bond Prices over Time
The formula for calculation of a single period holding-period return and an example are presented here.
14.5 Default Risk and Bond Pricing
This section presents bond default risk, also known as credit risk. The rating systems contain major and
sub-categories that allow for differentiation in the major categories. The highest four major categories are
This section also presents a list of factors that can be used in protection against default. Sinking funds can
prevent a crisis at maturity since they require the firm to systematically repay the principal. The larger
cash flow requirements of a sinking fund can substantially reduce coverage and cash flow ratios prior to
maturity and may not serve their intended purpose for all issues. Subordination of future debt and
dividend restrictions serves to protect existing creditors. Collateral provides the protection of asset value
in case of default.