Summary: Financial Market

Read the summary and the most important questions on Financial market

• 3 Valuing Bonds

• 3.1 Using the Present Value Formula to value bonds

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•  What is the bond’s principal?

  If you own a bond, you are entitled to a fixed set of cash payoffs. Every year until the bond matures, you collect regular interest payments. At maturity, when you get the final interest payment, you also get back the face value of the bond, which is called the bond’s principal.

• A bonds opportunity cost of capital equals?

  Equals the rate of return offered by other government debt issues (

• What is selling at a premium? and discount?

  A bond that is priced above its face value is said to sell at a premium. Investors who buy a bond at a premium face a capital loss over the life of the bond, so the yield to maturity on these bonds is always less than the current yield.
  
  
  A bond that is priced below value sells at a discount. Investors in discount bonds look forward to a capital gain over the life of the bond so the yield to maturity on a discount bond is greater than the current yield.

• How do you calculate the yield to maturity?

  The only general procedure for calculating the yield to maturity is trial and error. You guess at an interest rate and calculate the present value of the bond’s payments. If the present value is greater than the actual price, your discount rate must have been too low, and you need to try a higher rate.

• Where can you buy Treasury bonds, notes or bills ?

  You can’t buy Treasury bonds, notes or bills on the stock exchange. They are traded by a network of bond dealers, who quote prices at which they are prepared to buy and sell.

• 3.2 How Bond Prices vary with interest rates

• What is the link between bond prices and interest rates?

  
  Bond prices and interest rates must move in opposite directions. The yield to maturity, our measure of the interest rate on a bond, is defined as the discount rate that explains the bond price.
  
  When bond prices fall, interest rates (that is, yield to maturity) must rise. When interest rates rise, bond prices must fall.

• What's the face value of treasury notes and bonds

  Treasury notes and bonds come with maturities of 10 to 30 years. Both a 10-year and 30-year Treasury hold a minimum face value amount of $1,000,

• What is the formula for ROI of a bond?

  ROI= coupon income+price change/Investment

• What is the impact of changing interest rates?

  Changes in interest rates have a greater impact on long term cash flows rather than short term cashflows. 
   

• How do you predict the exposure of each bonds price to fluctuations on interest rates?

  Through the duration/ Macaulay duration, which is the weighted average of the times to each payment. 
  
  Duration= 1xPV(C1)/PV +  2xPV(C2)/PV etc.