Relationship Between Interest Rates And Bond Prices

Running head: VALUATION OF BONDS _FUNDAMENTALS OF FINANCE
Valuation of Bonds _Fundamentals of Finance
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1VALUATION OF BONDS _FUNDAMENTALS OF FINANCE
Table of Contents
1. Explaining impact of call provision for bond issuers, while detecting why bond issuers
exercise a call provision:............................................................................................................2
2. Defining a discount bond and a premium bond:....................................................................2
3. Describing the relationship between interest rates and bond prices:.....................................3
4. Describing the differences between a coupon bond and a zero coupon bond:......................3
9. Price of zero-coupon bond:....................................................................................................4
10. Price of coupon bond:..........................................................................................................4
11. Calculating the yield to maturity:.........................................................................................4
References and Bibliography:....................................................................................................5

2VALUATION OF BONDS _FUNDAMENTALS OF FINANCE
1. Explaining impact of call provision for bond issuers, while detecting why bond issuers
exercise a call provision:
Call provision mainly provide bond issuers with right to redeem a bond before its
maturity. This call provision mechanism mainly supports the issuer in time of lower interest
rates, which might help them to buy back the existing bonds and issue new bonds at lower
interest rates. This method would allow them to save money and improve the debt
combination in their balance sheet, where lower interest payments would improve the level of
profits for the organisation and vice versa. Furthermore, the call provision directly enables
the bond issuer to adequately minimize the overall rate of interest by buying back the bonds,
while making certain premium payments to the investors.
There are certain key takeaways from the call provision that needs to be maintained
by organization issuing bonds.
 Call provisions directly allow the organization a provision on the overall other fixed
income instrument and bonds purchase, where it could be retired before the maturity date.
 The call provision can be triggered at the present price and depict the overall specific
period can be hold by issuer. Moreover, bonds with call provision directly provide
investors higher interest rate than the non-cancellable bonds (Tewari, Byrd & Ramanlal,
2015).
 Lastly, call provision directly help companies to refinance their overall debt conditions by
reducing the interest rate debts from the capital market.
2. Defining a discount bond and a premium bond:
Discount bond is considered to be an instrument where it is traded below the issue
price. On the other hand, premium bonds are the financial instruments that trade above the
issuance price. From the overall analysis, it is detected that bonds issued have certain par

3VALUATION OF BONDS _FUNDAMENTALS OF FINANCE
value, which is mainly the overall money that is returned to the investors when they reach
maturity level. Thus, before the maturity date of the overall price of the bond mainly
fluctuates due to the change in the interest rates and bond coupon payments. Hence, relevant
examples are depicted for understanding the difference in the discount bond and premium
bond.
Example of discount bond:
The bond of $1,000 par value with interest rate 10% and coupon payment 7% would
have a discounted price of $700. Thus, investors would be providing only $700 for the
particular bond, which is considered to be trading at the discount, as interest rate is higher
than the coupon payment (Grundy & Verwijmeren, 2016).
Example of premium bond:
The bond of $1,000 par value with interest rate 5% and coupon payment 4% would
have a premium value. Thus, investors would be providing premium value for the particular
bond, as interest rate is lower than the coupon payment.
3. Describing the relationship between interest rates and bond prices:
The interest rate and bond price has direct relationship, as bonds have fixed interest
payment known as coupon rates, which are generally higher than the current interest rates.
Therefore, if the interest rate further drops the demand for the bond increases, which in turn
pushes the prices more for the bond. In the similar instance, if the interest rates in general
increase than the coupon payment of the bond, then it makes the instrument less demanded by
the investors. This would reduce the bond price in the market due to the falling demand from
investment, which directly states that the increment or decline in interest rates have direct
impact on the bond prices (Kwok, 2014).

4VALUATION OF BONDS _FUNDAMENTALS OF FINANCE
4. Describing the differences between a coupon bond and a zero coupon bond:
The major difference between coupon and zero coupon bonds are depicted as follows.
 Normal bond pays interest to bondholders, whereas zero-coupon bond gives no interest
payment
 Zero-coupon bond is considered to have higher returns than a regular bond (King &
Mauer, 2014).
 Zero-coupon bonds are considered more volatile in comparison to coupon bonds, as
speculation profit are anticipated short-term price movement.
9. Price of zero-coupon bond:
Particulars Value
Interest rate per semi-
annual 2.75%
Number of periods 6.00
Par value of bond $1,000.00
Price of bonds $ 849.78
10. Price of coupon bond:
Particulars Value
Interest rate per semi-
annual 3.60%
Number of periods 20.00
Par value of bond $1,000.00
Coupon rate 2.50%
Coupon payment $ 25.00
Price of bonds $ 845.07
11. Calculating the yield to maturity:
Particulars Value
Market price $1,025.95
Number of periods 36.00
Par value of bond $1,000.00

5VALUATION OF BONDS _FUNDAMENTALS OF FINANCE
Coupon rate 2.33%
Coupon payment $ 23.25
YTM 4.44%
References and Bibliography:
Grundy, B. D., & Verwijmeren, P. (2016). Disappearing Call Delay and Dividend‐Protected
Convertible Bonds. The Journal of Finance, 71(1), 195-224.
King, T. H. D., & Mauer, D. C. (2014). Determinants of corporate call policy for convertible
bonds. Journal of Corporate Finance, 24, 112-134.
Kwok, Y. K. (2014). Game option models of convertible bonds: Determinants of call
policies. Journal of Financial Engineering, 1(04), 1450029.
Sherman, E. H. (2011). Finance and accounting for nonfinancial managers (3rd ed.). New
York, NY: American Management Association.
Tewari, M., Byrd, A., & Ramanlal, P. (2015). Callable bonds, reinvestment risk, and credit
rating improvements: role of the call premium. Journal of Financial
Economics, 115(2), 349-360.
Weaver, S. C., & Weston, J. F. (2001). Finance and accounting for nonfinancial managers.
New York, NY: McGraw-Hill.