7.docx - Chapter 7 Interest Rates and Bond Valuation 7.1 Bond Features and Prices Bond interest-only loan Coupon Interest payment Face Value Par Value

7.docx - Chapter 7 Interest Rates and Bond Valuation 7.1...

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Chapter 7: Interest Rates and Bond Valuation 7.1 Bond Features and Prices Bond — interest-only loan Coupon — Interest payment Face Value / Par Value — Principal amount Coupon Rate — Annual coupon divided by face value Maturity — Date on which the principal amount is paid Bond Values and Yields 1. Increase in interest rates = Decline in bond’s PV 2. Decrease in interest rates = Increase in bond’s PV 3. Yield to Maturity (YTM) = Rate required in the market on a bond 7.2 More about Bond Features Differences between debt and equity: 1. Debt is not an ownership interest in the firm. Creditors do not have voting power 2. The corporation’s payment of interest on debt is considered the cost of doing business and is fully tax deductible. Dividends paid to stockholders are not tax deductible 3. Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. The action can result in liquidation and reorganization (two of the possible consequences of bankruptcy). One of the costs of issuing debt is the possibility of financial failure. Is it debt or equity? Corporations are adept at creating weird securities that have many features of equity but are treated as debt They want the tax benefits of debt and the bankruptcy benefits of equity Equity represents an ownership interest and is a residual claim Equity holders are paid after debt holders Long-term debt: the basics 1. ST Debt/ Unfunded Debt = maturities of 1 year or less 2. LT debt = maturities of > 1 year 3. Debt securities are called notes, debentures, or bonds 1 Note = 10 years or less 2 Bond = more than 10 years 4. Major forms of LT debt: Public Issue Privately Placed (w/ lender)
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The Indenture (Deed of Trust) Written agreement between the corporation and its creditors Usually, a trustee is appointed by the corporation to represent bondholders must make sure the terms of the are obeyed manage the sinking fund represent bondholders in default Includes: basic terms of the bond total amount of bonds issued description of property used as security repayment arrangements call provisions details of protective covenants Terms of a Bond Corporate bonds usually have a face value of $1000 1 This principal value is stated on the bond certificate 2 If a company wanted to borrow $1M, 1,000 bonds have to be sold 3 The par value (initial accounting value) is almost always the same as the face value and terms are use interchangeably in practice R egistered form 1 The registrar of the company records ownership of each bond; payment is made directly to the record’s owner 2 May be registered and have attached “coupon” Bearer Form 1 The bond is issued without record of the owner’s name; payment is made to whomever owns the bond 2 Cons: 1 Difficult to recover if lost or stolen 2 Company cannot notify bondholder of important events 3 Were once the dominant type Security
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