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Midterm #2 Study Guide

# Midterm #2 Study Guide - Midterm#2 Chapter 6(Interest Rates...

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Unformatted text preview: Midterm #2 Chapter 6 (Interest Rates and Bond Valuation) Bonds and Bond Valuation: bonds: when a corporation wishes to borrow money from the public on a long-term basis, and issues or sells debt securities bond features and prices a bond is usually an interest-only loan coupon – a stated interest payment made on a bond; it’s constant and paid every yr face value/par value – the principal amount of a bond that is repaid at the end of the term usually \$1000 for corporate bonds coupon rate – the annual coupon divided by the face value of a bond maturity – date on which the principal amount of a bond is paid bond values and yields when interest rates rise, the % of the bond’s remaining cash flows declines, and the bond is worth less; when interest rates fall, the bond is worth more yield to maturity (YTM)/bonds yield – the rate required in the market on a bond the annuity components are the coupons and the lump sum is the face value paid at maturity, and when added together equals the price of the bond when a bond sells for less than face value, it is said to be a discount bond when a bond sells for more than face values, it is said to be a premium bond interest rate risk RISKS: 1. all other things being equal, the longer the time to maturity, the greater the interest rate risks 2. all other things being equal, the lower the coupon rate, the greater the interest rate risk the value of a bond depends on the present value of its coupons and the present value of the face amount finding the YTM: more trial and error current yield – a bond’s annual coupon divided by its price More on Bond Features person making the loan is called the creditor, or lender the corporation borrowing the money is called the debtor or borrower difference btw debt and equity debt is not an ownership interest in the firm, Creditors generally don’t have voting power Corporation’s payment of interest on debt is considered a cost of doing business and is fully tax deductible. dividends paid to stockholders are not tax deductible unpaid debt is a liability of the firm and if not paid, creditors can legally claim the assets of the firm. one of the costs of issuing debt is the possibility of financial failure, which does not arise when equity is issued is it debt or equity? one reason corp. try to create a debt security that is really equity is to obtain the tax benefits of debt and the bankruptcy benefits of equity equity holders are paid after debt holders long-term debt: The basics the maturity of a long-term debt instrument is the length of time the debt remains outstanding with some unpaid balance debt securities are typically called notes, debentures, or bonds 2 major forms are public issue and privately placed difference is the latter is directly placed with a lender and not offered to the public the Indenture indenture – the written agreement btw the corporation and the lender detailing the terms of the debt issue includes the basic term of bond, total amount of bonds issued, a description of property used as...
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Midterm #2 Study Guide - Midterm#2 Chapter 6(Interest Rates...

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