September 14, 2004
Bonds
We begin by valuing a 10% 30-year $1,000 coupon bond at discount rates of 5%, 10%, and 15%.
If the interest rate is 10%, you can replicate the bond payment stream with a $1,000 bank deposit. Therefore, a 10% coupon bond is worth its face value if the interest rate is still 10%.
Higher inflation is the leading cause of higher interest rates. Therefore, "bondholders hate inflation."
The bond yield is in the WSJ bond table.
The bond yield is that R such that the present value of the bond payment stream is equal to the current bond price.
Bonus lecture: Duration.
Applying a little calculus allows us to calculate the duration for a pure discount bond. The duration is the percentage change in market value caused by a one percent change in interest rates. Duration is a widely used one-number statistic summarizing the riskiness of a bond portfolio.
