Valuing Traditional Fixed-Rate Corporate Bonds

Donald J Smith

Chapter 2 in Valuation in a World of CVA, DVA, and FVA:A Tutorial on Debt Securities and Interest Rate Derivatives, 2017, pp 13-45 from World Scientific Publishing Co. Pte. Ltd.

Abstract: This chapter addresses the valuation of a traditional fixed-rate corporate bond that does not have an embedded call or put option. The classic method to value the bond is discounted cash flow (DCF) analysis. Each scheduled coupon and principal payment is discounted back to Date 0 using a spot (or zero-coupon) rate that matches the time until the receipt of the cash flow and that reflects the investor’s required rate of return given the risk. For an N-period bond making N evenly-spaced coupon payments (PMT) and having the redemption of principal (FV) entirely at maturity, the price of the bond (PV) depends on the sequence of spot rates (Z1, Z2, … , ZN): PV=PMT(1+Z1)1+PMT(1+Z2)2+...+PMT + FV(1+ZN)N Often a single discount rate, known as the yield to maturity (Y), is used in lieu of the sequence of spot rates: PV=PMT(1+Y)1+PMT(1+Y)2+...+PMT + FV(1+YN)N This yield to maturity is the internal rate of return on the cash flows, the uniform discount rate such that the present value of the coupon and principal payments equals the price. This yield can be interpreted as a “weighted average” of the spot rates with most of the weight on the final cash flow as it includes the principal…

Keywords: XVA; CVA; DVA; FVA; Debt Securities; Interest Rate Derivatives (search for similar items in EconPapers)
JEL-codes: G10 (search for similar items in EconPapers)
Date: 2017
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