# 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
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 This preview has intentionally blurred sections. Sign up to view the full version. View Full Document 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 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
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
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
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  =
Double the number of years, and divide required return and annual coupon by 2.

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## This note was uploaded on 03/04/2009 for the course FIN 221 taught by Professor Dyer during the Spring '08 term at University of Illinois at Urbana–Champaign.

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

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