Module 2 Week 4 Lecture Notes.docx - Module 2 Week 4...

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Module 2: Week 4Lecture 1: Bond ValuationBonds: Long-term (10+ years) debt securities issued by corps & gov agencies.Secured Bonds: Have collateral ex. Mortgage bondUnsecured bonds are called: debenture and sometimes subordinated debentures-Subordinated debentures: seniority over the others b/c you bought yours first. Paid first if bus. goes into bk-Junk bonds – greatly subordinated debentures.Over time, debentures become very risky – higher yield to be worth it.Bonds are typically registered – which means that they have a record of ownership.Bearer bonds: have no record of ownership. If it was stolen, it is now theirs. Like cashThe conditions of a bond are listed in the indenture:1.Rights of parties: neutral 3rdparty (trustee, probably a bank), company pays bank to make sure everyone does what supposed to do2.Restrictive provisions: can’t remove collateral, no call feature in 1st5 years, only call 20% per year…3.Sinking fund: If a company sells 100mil. in bonds, it would be nice know they have a plan to pay it back.4.Call feature: Means the company can require you to sell the bond back to them. We don’t like! Company likes5.Convertible Feature: You can convert to specific # of common stockTerms:Coupon Rate: interest rate (fixed)Par value: (most have par value of $1,000)Maturity: Specific date Most bonds pay semi-annual interestConvertible Bond: purchase a bond for $970 that has a $1,000 par value. You can convert the bond into 25 shares of common stock, which is what is currently selling for $30 a share.Conversion Price = Par / Conversion Ratio = 1,000/25 = $40 per shareBreakeven PriceConversion Ratio = Par / Conversion Price = 1,000/40 = 25 shares*Conversion price or ratio will be given in problemConversion value = stock price x conversion ratio = $30 x 25 = $750Conversion premium = Bond price – conversion ratio = $970 – 750 = $220A couple notes about this:-If you were going to buy this bond w/intent of changing it into cs, you wouldn’t want to pay more than $750-Convertible bond will always sell at a healthy premium over this value b/c this is a bond & convertible, & you’re paying a conversion premium of $220.Always sell as a premium-If you think the price of the stock is going to go up, then it is reasonable to assume the price may go above & be worth it. -Bonds considered a safer investment than say common stock.

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