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CFFM6_ch 07_slides - Chapter 7 Bonds and Their Valuation...

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Bonds and Their Valuation Chapter 7 Key Features of Bonds Bond Valuation Measuring Yield Assessing Risk 7-1
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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. 7-2
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Bond Markets Primarily traded in the over-the-counter (OTC)  market. Most bonds are owned by and traded among  large financial institutions. The Wall Street Journal  reports key  developments in the Treasury, corporate, and  municipal markets.  Online edition lists trading  for each day the most actively-traded  investment-grade, high-yield, and convertible  bonds. 7-3
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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”). 7-4
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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. 7-5
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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. 7-6
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How are sinking funds executed? Call x% of the issue at par, for sinking fund  purposes. 7-7
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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% Value ... 7-8
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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 to the company prior to maturity. Income bond – pays interest only when interest  is earned by the firm. Indexed bond – interest rate paid is based upon  the rate of inflation.
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