You then want to include some examples of how bonds are valued, including:
a. How the value of any asset whose value is based on expected future cash flows is determined. The value of an asset is merely the present value of its expected future cash flows. If the cash flows have widely varying risk or if the yield curve is not horizontal, which signifies that interest rates are expected to change over the life of the cash flows, it would be logical for each period’s cash flow to have a different discount rate. However, it is very difficult to make such adjustments; hence it is a common practice to use single discount rates for all cash flows. The discount rate is the opportunity cost of capital that is, the rate of return that could be obtained on alternative investments of similar risk.
b. An example of the valuation of a 10-year, $1000 par value bond with a 6% annual coupon if the required return rate is 6%.
c. An example of what happens to the bond value above if the required return increases to 10% or decreases to 4%, particularly as it approaches maturity. Why might this be important to the client?
d. An example of yield to maturity, using a 10-year, 5%, annual coupon, $1000 par value bond that currently sells for $887 and the same bond selling for $1134.20. Why is the fact that a bond is a discount or premium bond matter to the client?
e. An example of how call provisions might impact the investment, considering a 10- year, 10%, semi-annual coupon bond with a par value of $1000, currently selling for $1135.90, producing a nominal yield to maturity of 8%. However, the bond can be called after four years for a price of $1050. You want to demonstrate the bond’s nominal yield to call and explain the likelihood of actually receiving either the YTM or YTC.