• Identify important bond features and types of bonds.

• Describe bond values and why they fluctuate.

• Discuss bond ratings and what they mean.
• Evaluate the impact of inflation on interest rates.
• Explain the term structure of interest rates and the
determinants of bond yields.

Professor Sol Kim 2

6.1 Bonds and Bond Valuation
6.2 More on Bond Features
6.3 Bond Ratings
6.4 Some Different Types of Bonds
6.5 Bond Markets
6.6 Inflation and Interest Rates
6.7 Determinants of Bond Yields

Professor Sol Kim 3

Professor Sol Kim 4
Professor Sol Kim 5
• Bond
– Borrow money from the public on a long-term basis

• Features
– Par value (face value)
– Coupon payment
– Coupon rate
– Maturity date
– Yield or Yield to maturity

Professor Sol Kim 6

• Par value:
– Face amount
– Re-paid at maturity
– Assume $1,000 for corporate bonds
• Coupon interest rate:
– Stated interest rate
– Usually = YTM at issue
– Multiply by par value to get coupon payment
• Maturity:
– Years until bond must be repaid
• Yield to maturity (YTM):
– The market required rate of return for bonds of similar risk and maturity
– The discount rate used to value a bond
– Return if bond held to maturity
– Usually = coupon rate at issue
– Quoted as an APR

Professor Sol Kim 7

 é1 - 1 ù é1 - 1 ù
ê (1 + r)t ú F ê (1 + 0.08)10 ú $1,000
Cê ú+ = $80 ê ú +
ú (1 + r) ú (1 + 0.08)
t 10
ê r ê 0.08
êë úû êë úû
= $1,000

Professor Sol Kim 8

• Bond Value = PV of coupons + PV of par
• Bond Value = PV annuity + PV of lump sum
• Remember
– As interest rates increase the PV’s decrease
– As interest rates increase, bond prices decrease and vice versa

Professor Sol Kim 9

 é 1 æ 1 öù
ê ç 1- t ÷ú
ê 1 + YTM è (1 + YTM ) ø ú F
Bond Value = C +
ê 1 ú (1 + YTM )t
ê 1- ú
êë 1 + YTM úû
é 1 ù
ê 1- (1 + YTM )t ú F
Bond Value = C ê ú+
ê YTM ú (1 + YTM ) t

êë úû
PV of the coupons PV of the face value

Professor Sol Kim 10

• Texas Instruments BA-II Plus
– N = number of periods to maturity
– I/Y = period interest rate = YTM
– PV = present value = bond value
– PMT = coupon payment
– FV = future value = face value = par value
• Spreadsheet Formulas
– =FV(Rate,Nper,Pmt,PV,0/1)
– =PV(Rate,Nper,Pmt,FV,0/1)
– =RATE(Nper,Pmt,PV,FV,0/1)
– =NPER(Rate,Pmt,PV,FV,0/1)
– =PMT(Rate,Nper,PV,FV,0/1)
– “0/1” Ordinary annuity = 0 (default) Annuity Due = 1 (must be
entered)

Professor Sol Kim 11

• Consider a bond with a coupon rate of 10% and coupons
paid annually. The par value is $1,000 and the bond has 5
years to maturity. The yield to maturity is 11%. What is the
value of the bond?
– Using the formula:
• B = PV of annuity + PV of lump sum
• B = 100[1 – 1/(1.11)5] / .11 + 1000 / (1.11)5
• B = 369.59 + 593.45 = 963.04
– Calculator Solution: 5 N, 11 I/Y, 100 PMT, 1000 FV, CPT PV = -
963.04

Professor Sol Kim 12

• Suppose you are looking at a bond that has a 10% annual
coupon and a face value of $1,000. There are 20 years to
maturity and the yield to maturity is 8%. What is the price
of this bond?
– Using the formula:
• B = PV of annuity + PV of lump sum
• B = 100[1 – 1/(1.08)20] / .08 + 1000 / (1.08)20
• B = 981.81 + 214.55 = 1196.36
– Calculator Solution: 20 N, 8 I/Y, 100 PMT, 1000 FV, CPT PV = -
1196.36

Professor Sol Kim 13

• Suppose you are looking at a bond that has a 10% annual
coupon and a face value of $1,000. There are 20 years to
maturity and the yield to maturity is 10%. What is the price
of this bond?
– Using the formula:
• B = PV of annuity + PV of lump sum
• B = 100[1 – 1/(1.10)20] / .10 + 1000 / (1.10)20
• B = 851.36 + 148.64 = 1000
– Calculator Solution: 20 N, 10 I/Y, 100 PMT, 1000 FV, CPT PV = -
1000.00

Professor Sol Kim 14

Professor Sol Kim 15
• If YTM = coupon rate, then par value = bond price
– Called a par bond
• If YTM > coupon rate, then par value > bond price
– Why?
– Selling at a discount, called a discount bond
• If YTM < coupon rate, then par value < bond price
– Why?
– Selling at a premium, called a premium bond

Professor Sol Kim 16

Premium CR>YTM

YTM = CR M
1,000

CR<YTM
Discount

30 25 20 15 10 5 0

Professor Sol Kim 17

• Find present values based on the payment period
– T = 7, C = 14%, YTM = 16%, F = 1,000
– How many coupon payments are there? 14 = 2 x 7 years
– What is the semiannual coupon payment? $70 = (14% x Face
Value)/2
– What is the semiannual yield? 8% = 16%/2
– B = 70[1 – 1/(1.08)14] / .08 + 1000 / (1.08)14 = 917.56

é ù
Cê 1 ú æ YTM ö F
Bond Value = ê1- ú /ç ÷ +
N ê (1 + YTM )tN ú è N ø (1 + YTM )tN
ë N û N
– 14 N, 8 I/Y, 70 PMT, 1000 FV, CPT PV = -917.56

Professor Sol Kim 18

• Price Risk
– Change in price due to changes in interest rates
– Long-term bonds have more price risk than short-term bonds
– Low coupon rate bonds have more price risk than high coupon rate
bonds

• Reinvestment Rate Risk

– Uncertainty concerning rates at which cash flows can be reinvested
– Short-term bonds have more reinvestment rate risk than long-term
bonds
– High coupon rate bonds have more reinvestment rate risk than low
coupon rate bonds

Professor Sol Kim 19

Professor Sol Kim 20
• Two bonds with different coupon rates and the same
maturity
• Lower coupon ⇒ more dependent on the face value ⇒
fluctuate more
• Higher coupon ⇒ larger cash flow early in its life ⇒ less
sensitive to changes in the discount rate

Professor Sol Kim 21

• Yield-to-maturity is the rate implied by the current bond
price
• Finding the YTM requires trial and error if you do not have
a financial calculator and is similar to the process for
finding r with an annuity
• With a financial calculator,
– Enter N, PV, PMT, and FV
• Remember the sign convention
– PMT and FV need to have the same sign (+)
• PV the opposite sign (-)
• CPT I/Y for the yield

Professor Sol Kim 22

• Consider a bond with a 10% annual coupon rate, 15 years
to maturity and a par value of $1000. The current price is
$928.09.
– Trial and Error
– Will the yield be more or less than 10%?
– 11%
– 15 N, -928.09 PV, 1000 FV, 100 PMT, CPT I/Y = 11%

Professor Sol Kim 23

• Suppose a bond with a 10% coupon rate and semiannual
coupons, has a face value of $1,000, 20 years to maturity
and is selling for $1197.93.
– Is the YTM more or less than 10%?
– What is the semiannual coupon payment?
– How many periods are there?
– Y= 4% (Is this the YTM?)
– 40 N, -1197.93 PV, 1000 FV, 50 PMT, CPT I/Y = 4%
– YTM = 4%*2 = 8%

Professor Sol Kim 24

• There is a specific formula for finding bond prices on a
spreadsheet
– PRICE(Settlement,Maturity,Rate,Yld,Redemption,Frequency,Basis)
– YIELD(Settlement,Maturity,Rate,Pr,Redemption, Frequency,Basis)
– Settlement and maturity need to be actual dates
– The redemption and Pr need to given as % of par value
• Click on the Excel icon for an example

Professor Sol Kim 25

• Debt • Equity
– Not an ownership interest – Ownership interest
– Creditors do not have voting – Common stockholders vote
rights
for the board of directors and
– Interest is considered a cost of other issues
doing business and is tax
deductible – Dividends are not considered
– Creditors have legal recourse a cost of doing business and
if interest or principal are not tax deductible
payments are missed – Dividends are not a liability
– Excess debt can lead to of the firm and stockholders
financial distress and have no legal recourse if
bankruptcy dividends are not paid
– An all equity firm can not go
bankrupt

Professor Sol Kim 26

• Not clear if debt or equity
• Create exotic, hybrid securities that have many features of
equity but are treated as debt
• Reason
– The tax benefits of debt
– The bankruptcy benefits of equity

Professor Sol Kim 27

• 씨에스윈드, 대규모 CB 발행…4천억원 자금 조달

• 2차전지 전구체 에코앤드림, SK온 대규모 수주…증설 목적 CB ...

• SK리츠, 세 번째 전환사채 발행 By Hankyung

• [특징주] 150억원 규모 CB 발행 성공… 마인즈랩, 10%대 강세 - 조

선비즈

Professor Sol Kim 28

• Indenture: the written agreement between the borrower
and its creditor
• Contract between issuing company and bondholders
includes
– The basic terms of the bonds
– The total amount of bonds issued
– A description of property used as security, if applicable
– Sinking fund provisions
– Call provisions
– Details of protective covenants

Professor Sol Kim 29

Professor Sol Kim 30
• Registered Forms (기명채)
– Registered: record the ownership of each bond and record any
change in ownership (common)
– Borrower will pay the interest and principal by check mailed directly
to the address of the owner of record

• Bearer Forms (무기명채)

– Bearer: not record, pay the bearer
– Drawbacks
• Difficult to recover if they are lost or stolen
• Difficult to notify bondholders of important events

Professor Sol Kim 31

• Collateral – secured by financial securities (bonds or stocks)
– Commonly used to refer to any asset pledged on a debt
• Mortgage – secured by real property, normally land or
buildings

• Debentures (무담보회사채)
– Unsecured & claim on property not pledged
– Notes – unsecured debt with original maturity less than 10 years
– Holders only have a claim on the property that remains after
mortgages and collateral trusts are taken into account

Professor Sol Kim 32

• Seniority
– Preference in position over other lenders and debts
– Senior (선순위채) vs. subordinated (후순위채)

• Repayment
– Sinking fund (감채기금)
– Repaid at maturity → repaid in part before maturity
– Managed by the bond trustee
– Buying up some of the bonds or call the outstanding bonds

Professor Sol Kim 33

• Allow the company to repurchase, or “call”, part or all of
the bond issue at stated prices over a specific period
• When does the company call the bond?
• Above the bond’s stated value
• Call price – stated value = call premium
• Not usually operative during the first part of a bond’s life:
deferred call provision & call protected

Professor Sol Kim 34

• Positive or negative
• Negative
– Limit the amount of dividends
– Not pledge any assets to other lenders
– Not merger with another firm
• Positive
– Maintain its working capital at or above some…
– Maintain any collateral or security in good condition

Professor Sol Kim 35

• Two leading bond-rating firms
– Moody’s and Standard and Poor’s (S&P)
– In Korea, 한국신용평가(한신평, KIS, Moody’s), 나이스신용평가(나이
스, NICE), 한국기업평가(한기평, KR, Fitch)

• Assessment of the credit-worthiness of the corporate issuer

– Credit-worthiness: how likely the firm is to default and the
protection creditors have in the event of a default (credit risk)
– Do not address the price risk (market risk)
– Highly rated bond can still be quite volatile.

Professor Sol Kim 36

Professor Sol Kim 37
신용평가시장 선진화 방안, 신평사 '신뢰 회복' 전기 될까

21일 금융위 '신용평가시장 선진화 방안'발표 등급장사땐 퇴출…"3사 체제서 가능성 작아" "제 4신용평가사 보류는 아쉬운 대목" 독자
신용등급 명시 의무…LIG건설, KT ENS사태 예방

[서울=뉴시스]남빛나라 기자 = 금융위원회가 21일 발표한 신용평가시장 선진화 방안은 신용평가회사의 신뢰도를 높이기 위한 대책
을 담고 있다. 그간 등급장사, 등급인플레, 뒷북등급 등의 관행이 드러나며 투자자의 신뢰를 잃은 신평사의 평가체계를 구조적으로 개
선하겠다는 것이다. 이날 금융위가 공개한 '신용평가의 신뢰 제고를 위한 신용평가시장 선진화 방안'에 따르면 불건전한 영업행위를
한 신평사는 인가취소 조치를 받을 수 있고, 기업을 평가할 때 외부의 지원가능성을 배제한 자체신용도(독자신용등급)를 명시해야 한
다. 다만 약 3분의 1씩 시장을 점유하고 있는 3대 신평사(한국기업평가·한국신용평가·나이스신용평가)의 과점 체제를 해소하기 위한
제4 신평사의 도입은 일단 연기됐다. 황세운 자본시장연구원 실장은 "그간 신용평가 시장이 지나치게 발행 기업 중심으로 돌아가고
있었는데 그런 권력관계를 평가사들 쪽으로 돌리고 투자자들의 이해를 반영하는 쪽으로 제도 변화가 이뤄졌다"며 "다만 제4 신평사
도입이 보류된 점이 아쉽다"고 평가했다.

◇등급장사, '영업정지→설립인가 취소'로 제재 강화

현재 신용평가사가 이른바 '등급장사' 등의 불건전 영업행위를 하면 영업정지 수준의 조치가 가능하다. 이번 선진화 방안에 따르면 설
립인가 취소 처분을 받고 사실상 시장에서 퇴출될 수 있다. 그간 신평사가 계약을 따내기 위해 기업 측에 후한 신용등급을 암묵적으
로 약속한 뒤 수수료를 지급받거나, 등급 하향조정 시기를 미뤄주는 등의 관행이 있어왔다. 신평사는 기업으로부터 수수료를 받고 해
당 기업에 대한 신용을 평가한다. 이 때문에 기업과 신평사 간 갑을관계가 굳어졌다는 지적이 꾸준히 제기됐다. … 복수평가제에 따라
기업은 기업어음(CP)이나 회사채 등을 발행할 때 최소 두 곳 이상의 신평사들로부터 등급평가를 받아야 하기 때문이다. ……금융위는
발행 기업이 신평사 선정을 신청하는 경우 복수평가 의무를 면제해줄 방침이다. 기업 스스로 평가 기관을 선정할 수 있는 권한을 버
리면 제3의 공적기관이 신평사를 선정해주는 만큼, 1개 등급만으로도 회사채 발행을 허용해주겠다는 취지다.

◇자체신용도 2018년까지 일반기업에도 적용

….LIG건설과 KT ENS의 사례 등이 불거지며 자체신용도가 필요하다는 목소리가 커졌다. 지난 2014년 KT ENS는 재무위기에 빠져 자
체 상환능력이 저조했지만 대기업인 KT의 계열사라는 이유로 A등급을 받았다. 지난 2011년에는 신평사들이 모기업인 LIG그룹의 지
원 가능성을 고려해 LIG건설의 기업어음(CP)에 투자적격 등급을 부여했지만 LIG건설은 법정관리를 신청, 신용등급을 믿고 어음을 사
들인 투자자들의 손실로 이어졌다. …..

Professor Sol Kim 38

A등급 남발 '기업신용 인플레'…글로벌 기준 땐 부도율 4배 증가

‘투자적격’ 부도율 3년째 상승

12일 금감원이 국내 3대 신평사의 신용평가실적을 분석한 결과 ‘투자적격등급 회사채 부도율’은 지난해 0.50%로 2012년
(0.41%)보다 0.09%포인트 높아졌다. 부도율은 연초 해당 신용등급을 보유한 업체 중 해당 연도에 몇개 업체가 부도를 냈
는지를 보여주는 것으로 등급이 얼마나 정확한지를 측정하는 지표로 쓰인다. 국내 투자적격등급 부도율은 2009~2010년
엔 0%에 머물렀지만 2011년 0.23%로 높아진 뒤 2012년에 이어 작년까지 상승세를 탔다. 특히 지난해 BBB급 구간의 부도
율은 3.52%까지 치솟으면서 외환위기 직후인 1998년 이후 최고치를 나타냈다. 지난해 동양시멘트 STX팬오션 등 BBB등급
기업들이 잇따라 부도를 낸 탓이다. 투기등급(BB+ 이하) 부도율은 지난해 6.24%로 2012년(15.66%)보다 크게 낮아졌다. 이
는 투기등급에 해당하는 기업 수가 2012년 83개에서 작년 109개로 늘어나 부도율의 변동성이 커진 데 따른 것이라고 금
감원은 설명했다.

“실질 신용위험 반영 못해”

글로벌 신평사 기준으로 재산정한 국내 부도율은 최대 4배로 높아지는 것으로 조사됐다. 국내 신평사들은 부도율을 계산
할 때 기업회생절차(법정관리)나 파산 등 ‘법률적 부도’가 난 기업만을 대상으로 한다. 반면 글로벌 신평사들은 여기에 워
크아웃(기업개선작업)이나 기업구조조정촉진법 적용에 따른 채무재조정 등을 포함하는 ‘경제적 의미의 부도’ 개념을 사용
한다. 글로벌 신평사 기준을 사용하면 2009년과 2010년 투자적격등급 부도율은 각각 0%에서 1.65%, 1.36%로 뛰었다. 부
도율 산정 기간을 늘리면 이 차이는 더 벌어졌다. 예를 들어 지난해까지 A등급 회사채를 3년간 보유했을 때의 부도율(3년
누적부도율)은 국내 신평사 기준으로 0.46%에 머물렀지만 글로벌 기준으론 1.96%로 높아졌다. 차이가 4배에 달한다. 금감
원 관계자는 “장기적으로는 글로벌 기준에 맞춰 워크아웃·기촉법에 따른 채무재조정 등도 부도율 산정에 포함하는 방안을
검토할 것”이라고 말했다.
한 투자은행(IB) 업계 관계자는 “시장 규모가 800억원에 불과한 상황에서 국내 신평사들은 평가대상 기업인 발행사로부터
수수료를 받는 영업 구조를 갖고 있어 발행기업과의 관계가 등급에 영향을 줄 가능성이 큰 상황”이라고 말했다. 이와 관련,
금감원은 동양그룹 계열사 회사채와 기업어음(CP)의 신용등급을 매긴 3사 신평사에 대해 지난해 말부터 실시한 특수검사
에서 등급평가와 관련 불법 영업의 정황을 일부 포착한 것으로 알려졌다.

Professor Sol Kim 39

• Treasury Securities
– Federal government debt: risk-free security
– T-bills – pure discount bonds with original maturity of one year or
less
– T-notes – coupon debt with original maturity between one and ten
years
– T-bonds - coupon debt with original maturity greater than ten years

• Municipal Securities
– Debt of state and local governments
– Varying degrees of default risk, rated similar to corporate debt
– Interest received is tax-exempt at the federal level
– Interest usually exempt from state tax in issuing state

Professor Sol Kim 40

• A taxable bond has a yield of 8% and a municipal bond has
a yield of 6%
– If you are in a 40% tax bracket, which bond do you prefer?
• 8%(1 - .4) = 4.8%
• The after-tax return on the corporate bond is 4.8%, compared to a 6%
return on the municipal
– At what tax rate would you be indifferent between the two bonds?
• 8%(1 – T) = 6%
• T = 25%

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• Make no periodic interest payments (coupon rate = 0%)
• The entire yield-to-maturity comes from the difference
between the purchase price and the par value
• Cannot sell for more than par value
• Sometimes called zeroes, or deep discount bonds
• Treasury Bills and U.S. Savings bonds are good examples
of zeroes

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• Tax purpose
– Issuer: deducts interest every year even though no interest is actually
paid
– Owner: pay taxes on interest every year even though no interest is
actually received
– Why invest? the future value is known with relative certainty.
1000
1.15 4

1000
1.15

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• Coupon rate floats depending on some index value
• Examples – adjustable rate mortgages and inflation-linked
Treasuries
• There is less price risk with floating rate bonds
– The coupon floats, so it is less likely to differ substantially from the
yield-to-maturity
• Coupons may have a “collar” – the rate cannot go above a
specified “ceiling” or below a specified “floor”

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포스코건설, 4천억 채권발행 '난항'…FRN검토

포스코건설이 건설업체에 대한 기관투자자의 재무적 우려 탓에 4천억원에 달하는 회사채를

발행하는데 애를 먹고 있다.
24일 증권업계에 따르면 포스코건설('AA-')은 기존 계획상의 4천억원 채권의 발행규모를 줄
이고, 나머지 금액을 금리변동부 외화표시채권(FRN) 발행할 것을 검토중인 것으로 알려졌
다.
조달한 자금은 오는 3월17일 만기도래하는 3억8천만달러 FRN을 롤오버할 예정이다. 주관
사는 KB투자증권으로 계약할 예정이다.
포스코건설은 열흘전만 하더라도 1년물·2년물·3년물·5년물 각 1천억원씩 4천억원의 회사채
를 다음 달 말 발행할 예정이다.
그러나 기관투자자들은 포스코건설이 내달말 작년 사업보고서가 나오기전에 4천억원에 달
하는 대규모 자금을 발행하는데 우려하는 것으로 알려졌다.
건설금융 분야 관계자는 "작년 일부 건설사가 수천억원의 적자를 내기전에 1조원의 자금을
조달한 전례가 있다"며 "작년 대형건설사 대부분 수천억원의 영업손실을 낸 것도 크게 작용
하는 것으로 알고 있다"고 말했다.

이에 대해 포스코건설 관계자는 "4천억원을 원화채권으로 발행한다는 기존 계획은 그대로

다"며 "다만 사정이 여의치 않을경우 발행규모를 줄이고, 나머지는 현금상환하거나 FRN을
발행하는 등 다양한 방안을 검토할 것"이라고 설명했다.

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• Disaster bonds
• Income bonds
– dependent on company income / not common
• Convertible bonds (lower return)
– Covert to shares of stock before maturity
• Callable bond (higher return)
– The call provision
• Puttable bond (lower return)
– Reverse of the call provision
• There are many other types of provisions that can be added
to a bond and many bonds have several provisions – it is
important to recognize how these provisions affect
required returns
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• Larger than the trading volume in stocks
• Primarily over-the-counter transactions with dealers
connected electronically
– No transparency
• Extremely large number of bond issues, but generally low
daily volume in single issues
• Makes getting up-to-date prices difficult, particularly on
small company or municipal issues
– A variety of sources of estimated prices: bond pricing company
• Treasury securities are an exception

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• Bloomberg Bond Site
https://www.bloomberg.com/markets/rates-bonds/government-
bonds/us

• 금융투자협회 채권정보센터
http://www.kofiabond.or.kr/

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Professor Sol Kim 49
5/15/2030 6.250 132.8984 132.9609 0.4688 2.949

• Maturity = May 15, 2030

• Coupon rate = 6.250% per year
• Bid price = 132.8984 % of par
– Price at which dealer is willing to buy from you
• Ask price = 132.9609 % of par
– Price at which dealer is willing to sell to you
• Bid-Ask Spread = Dealer’s profit
• Change = ask price is up .4688 % since the previous day
• Asked Yield = 2.949%

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• Quoted bond prices = “clean” price
– Net of accrued interest
• Invoice Price = “dirty” or “full” price
– Price actually paid
– Includes accrued interest
• Accrued Interest
– Interest earned since last coupon payment is owed to bond seller at ti
me of sale
Trading
100 day 100

1 year
A.I . : 100 ´ 0.5 = 50

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• Real rate of interest – change in purchasing power
• Nominal rate of interest – quoted rate of interest, change in
purchasing power and inflation
• The ex ante nominal rate of interest includes our desired
real rate of return plus an adjustment for expected inflation
– Pizza $5 ⇒ $5.25 (5% increase because of inflation)
– Investment: $100 ⇒ $115 (15% rate of return)
– Buy 20 pizzas ⇒ 22 pizzas (10% buying power)

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• The Fisher Effect defines the relationship between real rates,
nominal rates and inflation
• (1 + R) = (1 + r)(1 + h), where
– R = nominal rate (Quoted rate)
– r = real rate
– h = expected inflation rate
• Approximation
– R = r + h + rh
– R≈r+h

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• If we require a 10% real return and we expect inflation to
be 8%, what is the nominal rate?
• R = (1.1)(1.08) – 1 = .188 = 18.8%
• Approximation: R = 10% + 8% = 18%
• Because the real return and expected inflation are relatively
high, there is significant difference between the actual
Fisher Effect and the approximation.

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Professor Sol Kim 56
• Term structure is the relationship between time to maturity
and yields, all else equal
• The effect of default risk, different coupons, etc. has been
removed.
– Default-free, pure discount bonds of all maturities and a single,
lump-sum future payment (zero curve)
• Yield curve – graphical representation of the term structure
– Normal – upward-sloping, long-term yields are higher than short-
term yields
– Inverted – downward-sloping, long-term yields are lower than
short-term yields
– humped

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Professor Sol Kim 58
https://www.kofiabond.or.kr

Professor Sol Kim 59

• Real rate
– Basic component
– Doesn’t determine the shape of the term structure
• Inflation premium
– Future inflation erodes the value of the dollars that will be returned
– If inflation is higher in the future, nominal interest rate will be higher
than short-term rates.
• Interest rate risk premium
– Long-term bonds have much greater risk of loss resulting from
changes in interest rates
– So, interest rate risk premium increase with maturity

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Professor Sol Kim 62
• Default risk premium – remember bond ratings
• Taxability premium – remember municipal versus taxable
• Liquidity premium – bonds that have more frequent
trading will generally have lower required returns
• Maturity premium – longer term bonds will tend to have hi
gher required returns.
• Anything else that affects the risk of the cash flows to the
bondholders, will affect the required returns

Professor Sol Kim 63

• How do you find the value of a bond and why do bond
prices change?
• What is a bond indenture and what are some of the
important features?
• What are bond ratings and why are they important?
• How does inflation affect interest rates?
• What is the term structure of interest rates?
• What factors determine the required return on bonds?

Professor Sol Kim 64