Bonds
Study guide: Exam FM-2
A bond is a fixed-income debt instrument in which an issuer (borrower) promises to pay the bondholder (lender) periodic Coupon payments and to return the Face Value (par value) at maturity. Key bond terms:
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Face Value — Principal amount repaid at maturity (par value)
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Coupon Rate — Annual interest rate applied to face value to set coupon payments
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Coupon — Periodic interest payment = Face Value × Coupon Rate / payments per year
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Yield Rate — Rate of return actually earned by the bondholder (may differ from coupon rate)
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Price — Present value of all future cash flows at the yield rate
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Term of Bond — Time from issue to maturity
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Book Value — Amortized value of the bond at any point during its term
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The basic bond price formula:
P = Fr \cdot a_{\overline{n}|j} + C \cdot v^nwhereF= face value,r= coupon rate per period,C= redemption value,n= number of coupons,j= yield rate per period.
Bond Pricing A
1{,}000face value 5-year bond with 6% annual coupons is priced at a yield of 7%.Answer
P = 60 \cdot a_{\overline{5}|7\%} + 1000v^5 = 60(4.1002) + 1000(0.712986) = 246.01 + 712.99 = 959.00. The bond is redeemed at par (C = F = 1{,}000), so it sells at a discount (price below the redemption value) because its 6% coupon rate is below the 7% yield rate.