Investments, tenth edition

   Bond Pricing 

 If yields on different-maturity bonds are not all equal, how should we value coupon bonds 

that make payments at many different times? For example, suppose that yields on zero-

coupon Treasury bonds of different maturities are as given in  Table 15.1 . The table tells us 

that zero-coupon bonds with 1-year maturity sell at a yield to maturity of  y  

1

   5  5%,  2-year 

zeros sell at yields of  y  

2

   5  6%, and 3-year zeros sell at yields of  y  

3

   5  7%. Which of these 

rates should we use to discount bond cash flows? The answer: all of them. The trick is to 

consider each bond cash flow—either coupon or principal payment—as at least potentially 

sold off separately as a stand-alone zero-coupon bond.  

 Recall the Treasury STRIPS program we introduced in the last chapter (Section 14.4). 

Stripped Treasuries are zero-coupon bonds created by selling each coupon or principal 

payment from a whole Treasury bond as a separate cash flow. For example, a 1-year 

 Figure 15.1 

Treasury yield curves 

  Source: Various editions of  The Wall Street Journal.  Reprinted by  permission of  The Wall Street Journal,  © 1989, 2000, 2006, and 2012 

Dow Jones & Company, Inc. All Rights Reserved Worldwide. 

Treasury Yield Curve

Yields as of 4:30 

P.M.

 Eastern time

Percent

6.0

0.0

2.0

1.0

3.0

4.0

5.0

Year

Maturities

Months

B. (December 2012)

Rising Yield Curve

Treasury Yield Curve

Yields as of 4:30 

P.M.

 Eastern time

Treasury Yield Curve

Yields as of 4:30 

P.M.

 Eastern time

Treasury Yield Curve

Yields as of 4:30 

P.M.

 Eastern time

Percent

6.0

1

3

6 2

5 10

1.0

2.0

3.0

4.0

5.0

30

Maturities

Year

Months