## Explanatory Notes

{For New York and American Bonds) yield is Current yield.

cv-Convertlbie bond. cf-Certiflcates. cld-Called do-Deep discount. ec-Eurcpean cur-rercy units. f-Dealt in flat. IP-Italian lire, kd-Danish kroner. m-Matured bonds, negotiability impaired by maturity. na-No accrual, r-Registered. rp-Reduced principal, st, sd-Stamped. t-Floating rate, wd When distributed, ww-With warrants, x-Ex interest, xw-Wthout warrants. zr-Zero coupon, vj-ln bankruptcy or receivership or being reorganized under the Bankruptcy Act, or securities assumed by such companies.

Source: Reprinted by permission of The Wall Street Journal, via Copyright Clearance Center © 2001 Dow Jones and Company, Inc., May 11, 2001. All Rights Reserved Worldwide.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

III. Valuation of Future Cash Flows

7. Interest Rates and Bond Valuation

© The McGraw-Hill Companies, 2002

PART THREE Valuation of Future Cash Flows current yield

A bond's coupon payment divided by its closing price.

The bond's current yield (abbreviated as "Cur Yld") is also reported. The current yield is equal to the annual coupon payment divided by the bond's closing price. For this bond, assuming a face value of $1,000, this works out to be $60/938.75 = 6.39 percent, or 6.4 percent rounded off to one decimal place. Notice that this is not equal to the bond's yield to maturity (unless the bond sells for par). Finally, the volume for the day (the number of bonds that were bought and sold) is reported in the second column ("Vol"). For this particular issue, only 177 bonds changed hands during the day (in this market).

Sude 7.33 Treasury Quotations

### Current Yields

Following are several bond quotations for the Albanon Corporation. Assuming these are from The Wall Street Journal, supply the missing information for each.

Albanon 8s98 ?.? 8 84.5 +12 Albanon ?s06 9.4 8 74.5 +1/8 Albanon 8s10 9.0 8 ??.? +54

In each case, we need to recall that the current yield is equal to the annual coupon divided by the price (even if the bond makes semiannual payments). Also, remember that the price is expressed as a percentage of par. In the first case, the coupon rate is 8 percent and the price is 84.5, so the current yield must be 8/84.5, or 9.5 percent. In the second case, the current yield is 9.4 percent, so the coupon rate must be such that:

Therefore, the coupon rate must be about 7 percent. Finally, in the third case, the price must be such that:

Therefore, the price is 8/9, or 88.9 percent of par value.

The Federal Reserve Bank of St. Louis maintains dozens of on-line files containing macroeconomic data as well as rates on U.S. Treasury issues. Go to . www.stls.frb.org/fred/files.

bid price

The price a dealer is willing to pay for a security.

asked price

The price a dealer is willing to take for a security.

bid-ask spread

The difference between the bid price and the asked price.

As we mentioned before, the U.S. Treasury market is the largest securities market in the world. As with bond markets in general, it is an OTC market, so there is limited transparency. However, unlike the situation with bond markets in general, trading in Treasury issues, particularly recently issued ones, is very heavy. Each day, representative prices for outstanding Treasury issues are reported.

Figure 7.4 shows a portion of the daily Treasury note and bond listings from The Wall Street Journal. The entry that begins "8 Nov 21" is highlighted. Reading from left to right, the 8 is the bond's coupon rate, and the "Nov 21" tells us that the bond's maturity is November of 2021. Treasury bonds all make semiannual payments and have a face value of $1,000, so this bond will pay $40 per six months until it matures.

The next two pieces of information are the bid and asked prices. In general, in any OTC or dealer market, the bid price represents what a dealer is willing to pay for a security, and the asked price (or just "ask" price) is what a dealer is willing to take for it. The difference between the two prices is called the bid-ask spread (or just "spread"), and it represents the dealer's profit.

For historical reasons, Treasury prices are quoted in 32nds. Thus, the bid price on the 8 Nov 21 bond, 125:05, actually translates into 125 5/32, or 125.15625 percent of face value. With a $1,000 face value, this represents $1,251.5625. Because prices are quoted in 32nds, the smallest possible price change is 1/32. This is called the "tick" size.

The next number quoted is the change in the asked price from the previous day, measured in ticks (i.e., in 32nds), so this issue's asked price fell by 46/32 of 1 percent, or

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

III. Valuation of Future Cash Flows

7. Interest Rates and Bond Valuation

© The McGraw-Hill Companies, 2002

CHAPTER 7 Interest Rates and Bond Valuation

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