Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionIII. Valuation of Future
Cash Flows- Interest Rates and Bond
Valuation
(^258) © The McGraw−Hill
Companies, 2002
1.4375 percent, of face value from the previous day. Finally, the last number reported is
the yield to maturity, based on the asked price. Notice that this is a premium bond be-
cause it sells for more than its face value. Not surprisingly, its yield to maturity (5.86
percent) is less than its coupon rate (8 percent).
Some of the maturity dates in Figure 7.4 have an “n” after them. This just means that
these issues are notes rather than bonds. Other entries have a range of maturity dates.
These issues are callable. For example, locate the issue whose maturity is given as “May
05-10.” This bond is callable as of May 2005 and has a final maturity of May 2010. The
bonds with an “i” after them are the inflation-linked bonds we discuss in the next sections.
The very last bond listed, the 5 3/8 Feb 31, is often called the “bellwether” bond. This
bond’s yield is the one that is usually reported in the evening news. So, for example,
when you hear that long-term interest rates rose, what is really being said is that the
yield on this bond went up (and its price went down). In very recent times, attention has
shifted away from the long maturity bonds to the 10-year maturity range, and, in the fall
of 2001, the Treasury announced that it would no longer issue 30-year bonds.
If you examine the yields on the various issues in Figure 7.4, you will clearly see that
they vary by maturity. Why this occurs and what it might mean is one of the things we
discuss in our next section.
INFLATION AND INTEREST RATES
So far, we haven’t considered the role of inflation in our various discussions of interest
rates, yields, and returns. Because this is an important consideration, we consider the
impact of inflation next.
Real Versus Nominal Rates
In examining interest rates, or any other financial market rates such as discount rates,
bond yields, rates of return, and required returns, it is often necessary to distinguish be-
tween real ratesand nominal rates. Nominal rates are called “nominal” because they
have not been adjusted for inflation. Real rates are rates that have been adjusted for
inflation.
CONCEPT QUESTIONS
7.5a Why do we say bond markets have little or no transparency?
7.5bIn general, what are bid and ask prices?
7.5c What are some of the differences in the way corporate bond prices and Treasury
bond prices are quoted in The Wall Street Journal?
228 PART THREE Valuation of Future Cash Flows
Treasury Quotes
Locate the Treasury note in Figure 7.4 maturing in February 2008. What is its coupon rate?
What is its bid price? What was the previous day’sasked price?
The note listed as 5^1 ⁄ 2 Feb 08 is the one we seek. Its coupon rate is 5^1 ⁄ 2 , or 5.5 percent of
face value. The bid price is 102:08, or 102.25 percent of face value. The ask price is 102:10,
which is down by 18 ticks from the previous day. This means that the ask price on the previ-
ous day was equal to 102 10/32 18/32 102 28/32 102:28.
EXAMPLE 7.5
nominal rates
Interest rates or rates of
return that have not been
adjusted for inflation.
real rates
Interest rates or rates of
return that have been
adjusted for inflation.
7.6
Current and historical
Treasury yield information
is available at
http://www.publicdebt.
treas.gov/of/ofaucrt.htm.