Chapter_07 - CHAPTER 7 Bonds and Their Valuation Key...

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    7-1 CHAPTER 7 Bonds and Their Valuation Key features of bonds Bond valuation Measuring yield Assessing risk
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    7-2 What is a bond? A long-term debt instrument in which  a borrower agrees to make payments  of principal and interest, on specific  dates, to the holders of the bond.
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    7-3 Bond markets Primarily traded in the over-the-counter  (OTC) market. Most bonds are owned by and traded among  large financial institutions. Full information on bond trades in the OTC  market is not published, but a representative  group of bonds is listed and traded on the  bond division of the NYSE.
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    7-4 Key Features of a Bond Par value – face amount of the bond, which  is paid at maturity (assume $1,000). Coupon interest rate – stated interest rate  (generally fixed) paid by the issuer.  Multiply by par  value to get dollar payment of interest. Maturity date – years until the bond must be repaid. Issue date – when the bond was issued. Yield to maturity - rate of return earned on  a bond held until maturity (also called the “promised  yield”).
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    7-5 Effect of a call provision Allows issuer to refund the bond issue  if rates decline (helps the issuer, but  hurts the investor). Borrowers are willing to pay more,  and lenders require more, for callable  bonds. Most bonds have a deferred call and  a declining call premium.
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    7-6 What is a sinking fund? Provision to pay off a loan over its life  rather than all at maturity. Similar to amortization on a term  loan. Reduces risk to investor, shortens  average maturity. But not good for investors if rates  decline after issuance.
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    7-7 How are sinking funds executed? Call x% of the issue at par, for sinking  fund purposes. Likely to be used if r d  is below the coupon  rate and the bond sells at a premium. Buy bonds in the open market. Likely to be used if r d  is above the coupon  rate and the bond sells at a discount.
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    7-8 The value of financial assets N N 2 2 1 1 r) (1 CF     ...     r) (1 CF     r) (1 CF     Value + + + + + + = 0 1 2 N r% CF 1 CF N CF 2 Value ...
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    7-9 Other types (features) of bonds Convertible bond – may be exchanged for common  stock of the firm, at the holder’s option. Warrant – long-term option to buy a stated number  of shares of common stock at a specified price. Putable bond – allows holder to sell the bond back 
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This note was uploaded on 06/01/2009 for the course FIN 301 taught by Professor Andelin,stevenle during the Spring '07 term at Pennsylvania State University, University Park.

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Chapter_07 - CHAPTER 7 Bonds and Their Valuation Key...

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