Chapter7 - Bonds and Their Valuation 1 x Bond...

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Bonds and Their Valuation 1
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Bond Characteristics Annual and Semi-Annual Bond Valuation Finding Returns on Bonds Reading Bond Quotes Bond Risk and Other Important Bond Valuation Relationships 2
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Par (or Face) Value ( M ) = stated face value that is the amount the issuer must repay, usually $1,000 Coupon Interest Rate Coupon ( INT ) = Coupon Rate x Face Value Maturity Date = when the face value is repaid. A legal contract called the bond indenture specifies these values. This makes a bond’s cash flows look like this: 3
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Discount the bond’s cash flows at the investor’s required rate of return. the coupon payment (INT) stream (an annuity). the par (M) value payment (a lump sum). 4 0 0 1 1 2 . . . 2 . . . n n INT INT INT INT INT+M INT+M
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Duff’s Beer has $1,000 par value bonds outstanding that make annual coupon payments. These bonds have a 7% annual coupon rate and 15 years left to maturity. Bonds with similar risk have a required return of 9%, and Moe Szyslak thinks this required return is reasonable. What’s the most that Moe is willing to pay for a Duff’s Beer bond? 5
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0 1 2 3 . . . 15 1000 ? 70 70 70 . . . 70 r = 9% 6
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Homer Simpson is interested in buying a Duff Beer bond but demands an 7 percent required return. What is the most Homer would pay for this bond? 7
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0 1 2 3 . . . 15 1000 ? 70 70 70 . . . 70 r = 7% 8
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Barney (belch!) Gumble is interested in buying a Duff Beer bond and demands on a 5 percent required return. What is the most Barney (belch!) would pay for this bond? 9
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0 1 2 3 . . . 15 1000 ? 70 70 70 . . . 70 r = 5% 10
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Bond Values for 7.5% Annual Coupon Bond $0.00 $200.00 $400.00 $600.00 $800.00 $1,000.00 $1,200.00 $1,400.00 0% 2% 4% 6% 8% 10% Required Return ($)M arket Value 15-yr Bond 11
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What happens to bond values if required return is not equal to the coupon rate? 12 P 0  < par value r > Coupon Interest Rate DISCOUNT  = P 0   > par value r < Coupon Interest Rate PREMIUM    = P 0  = par value r = Coupon Interest Rate PAR  =
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Double the number of years, and divide required return and annual coupon by 2.
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