Lecture Note 2 (Ch5) - Lecturenote Chapter5 2 Outline

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    Lecture note Chapter 5
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    Outline 1. Definition and examples of bonds     Pure discount bonds, Level coupon bonds,         Consols. 2. Interests and Bond prices 3. Yield to Maturity 4. Present value of common stocks 5. Stock Market Reporting
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    Definition and example of a bond A bond is a certificate showing that a borrower  owes a specified sum. - Borrower has agreed to make interest and  principal payment. - Timing and amount of payment depends of the  bond.
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    Example of a bond Consider a company that issues a bond for $1000 which has  a coupon rate of 5 percent and maturity of two years.  Suppose that interest payment is made yearly and the  principal amount is paid at the end of two years. This means  that - A company borrowed $1000 - Coupon rate is 5%: This means that the firm has to pay the  interest of $50 (i.e., 5% of $1000) at the end of the first year  and the second year. - At the end of two year, in addition to the interest payment,  the firm has to pay $1000. The bond described above is an example. In the following  slides, we will consider the valuation of different kinds of  bonds.
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    Pure discount bond The pure discount bond is the simplest kind of bond.  - This bond promises a single payment.  - The date the borrower promises to make the payment  is called the maturity date. - The payment at the maturity date is called the face  value. Since the pure discount bond does not pay cash until  the maturity date, it is often called  a zero-coupon  bond .
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    Pure Discount Bond -Example- Consider a pure discount bond that promises you to  pay $1000 four years from today. This means that  the face value of the bond is $1000. The cash that  you will be receiving is illustrated in the following  table. date 1 year  2 year 3 year 4 year Cash  flow 0 0 0 $1000
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    Pure Discount Bond -Example, Contd- Clearly, the value of the pure discount bond in  the previous example is the discount value of  the face value. For example, if the market  interest rate is 10%. Then the value of the bond  is given by 01 . 683 ) 1 . 0 1 ( 1000 $ 4 = + Value of the bond= • Therefore, we can formalize the valuation of  the pure discount bond in the following way.                         See next page
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    Valuation of a pure discount bond Consider a pure discount bond with face value F,  and time to maturity T. Let r be the discount rate  (Discount rate is often referred to as the market  interest rate).
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This note was uploaded on 11/09/2009 for the course FINANCE 330 taught by Professor Seri during the Spring '09 term at Birzeit University.

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Lecture Note 2 (Ch5) - Lecturenote Chapter5 2 Outline

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