The meaning of Interest Rates - Bond Cash Flows, Prices, and Yields

9 important questions on The meaning of Interest Rates - Bond Cash Flows, Prices, and Yields

What is a bond certificate

It is a legal document that states the terms of the bonds

What is a maturity date

The final repayment date

What is a zero-coupon bond

A zero-coupon bond is a debt security instrument that does not pay interest.
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What are the criteria of a zero-coupon bond?

- does not make coupon payments
- always sells at a discount (a price lower than face value)--> also called pure discount bonds
- Treasury bills are U.S. Government zero-coupon bonds with maturity of up to one year

What is the Yield to maturity?

The discount rate that sets the present value of the promised bond payments equal to the current market price of the bond.

What are risk-free interest rates?

A default-free zero-coupon bond that matures
on date n provides a risk-free return over the
same period. Thus, the Law of One Price
guarantees that the risk-free interest rate equals the yield to maturity on such a bond.

What is a Zero-Coupon Yield Curve

A plot of the yield of risk-free zero-coupon bonds as a function of the bond’s maturity date

What is the YTM formula?

Formula:

Consider the following semi-annual bond:
• $1000 par value
• 7 years until maturity
• 9% coupon rate
• Price is $1,080.55

What is the bond's yield to maturity?

– N = 7 years x 2 = 14
– PMT = (9% x $1000)/ 2 = $45
...= 7.5%

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