Lecture 11 0301 - ORIE 350 March 1 2007 Bonds USA Note The...

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    ORIE 350 March 1, 2007 Bonds
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    USA Note The debt market in the USA is relatively lightly regulated and efficient. Other countries, notably Japan, rely on banks for most of their debt financing. If you do business in the USA, you should consider debt financing.
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    Bankruptcy Keep in mind that creditors always get paid first. If a firm goes bankrupt and its assets are sold, the creditors are paid off first. If there is any money left over, the stockholders get it. There usually isn’t any!
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    Bonds The most common type of long-term debt is a bond. Bonds are normally due 10 to 15 years after issue, sometimes longer.
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    Bonds and Interest If interest payments are made on the bond, these payments are almost always made semiannually . The nominal annual interest rate of the bond interest is given. That is, we merely need to divide by c = 2 to get the periodic, semiannual rate. If no interest payments are made on the bond until it is due, it is a zero coupon bond.
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    Interest In the old days, the bond would come with coupons, which were mailed in to the firm or presented to your broker to claim the semiannual interest. This is largely obsolete for bonds, the payments are made automatically without the need for action on the creditors part.
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    Terms The company that issued the bond is a debtor, the person who purchases the bond is a creditor. The creditors’ claims for interest and principal take precedence over all stockholder’s claims. Secured bonds give the creditor claims to assets of the company upon default, unsecured bonds (a.k.a. debentures) do not.
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    Pricing  Bond prices are expressed as a percentage of the face value. For example, when bonds with a face value of $100,000 are issued at 97, this means they sell for $97,000.
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    Market Economy When the market demands a higher interest rate than the face interest rate, the bond will sell at a discount (less than face value). When the market demands a lower interest rate than the face interest rate, the bond will sell at a premium (more than face value).
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    Market Economy The price a bond sells for is determined by many factors, both exogenous and endogenous.
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