Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionIII. Valuation of Future
Cash Flows- Interest Rates and Bond
Valuation
(^256) © The McGraw−Hill
Companies, 2002
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 num-
ber 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).
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, representa-
tive 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 bidand asked prices. In general, in any
OTC or dealer market, the bid price represents what a dealer is willing to pay for a se-
curity, 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, mea-
sured in ticks (i.e., in 32nds), so this issue’s asked price fell by 46/32 of 1 percent, or
226 PART THREE Valuation of Future Cash Flows
Slide7.33Treasury
Quotations
current yield
A bond’s coupon
payment divided by its
closing price.
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 ^1 ⁄ 2
Albanon ?s06 9.4 8 74.5 ^1 ⁄ 8
Albanon 8s10 9.0 8 ??.? ^1 ⁄ 4
In each case, we need to recall that the current yield is equal to the annualcoupon 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:
Coupon rate/74.5% 9.4%
Therefore, the coupon rate must be about 7 percent. Finally, in the third case, the price must
be such that:
8%/Price 9%
Therefore, the price is 8/9, or 88.9 percent of par value.
EXAMPLE 7.4
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.
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
http://www.stls.frb.org/fred/files.