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CHAPTER 12
THE ANALYSIS AND VALUATION OF BONDS
I. Bond Valuation and Bond Yields
A. The Present Value Model
B. The Yield Model
II. Computing Bond Yields
A. Nominal (Coupon) Rate
D. Promised Yield to Call (YTC)
Whenever a bond with a call feature is selling for a price above par equal to or greater
than its call price, a bond investor should consider valuing the bond in terms of YTC
rather than YTM
1. Computing Promised Yield to Call
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IV. What Determines Interest Rates?
A. Forecasting Interest Rates
The ability to forecast interest rates and changes in these rates is critical to successful
bond investing
B. Fundamental Determinants of Interest Rates (Exhibit 12.3)
1. Risk-Free Rate, Expected Inflation and Risk Premium
V. The Term Structure of Interest Rates
Yield Curves (Exhibits 12.4 and 12.5)
B. Liquidity Preference Hypothesis
Long-term securities should provide higher returns than short-term obligations because
investors are willing to sacrifice some yields to invest in short-maturity obligations to
avoid the higher price volatility of long-maturity bonds
VI. What Determines the Price Volatility for Bonds?
Yield and Bond Price Volatility
1. Bond prices move inversely to bond yields
A. Trading Strategies
B. Duration Measures
1. Macaulay Duration
2. Characteristics of Macaulay Duration (Exhibits 12.6 and 12.7)
Duration of a bond is less than term to maturity (except zero coupon bonds)
Duration of a zero coupon bond equals to its maturity
1. Modified duration can be used to approximate the interest rate sensitivity of an
option-free (straight) bond
D. Bond Convexity
1. The Price-Yield Relationship for Bonds (Exhibits 12.9, 12.10, and 12.11)
a. The price-yield relationship is not a straight line but a curvilinear relationship (i.e.,
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2. Determinants of Convexity
Convexity is a measure of the curvature of the price-yield relationship
Factors and bond convexity
Inverse relationship between convexity and coupon