Combined Chapter 7

Combined Chapter 7 - 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 17-1
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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. 27-2
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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  37-3
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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  47-4
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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. 57-5
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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. 67-6
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How are sinking funds  § Call x% of the issue at par, for sinking fund  purposes. § Likely to be used if rd is below the coupon rate  and the bond sells at a premium. § Buy bonds in the open market. § Likely to be used if rd is above the coupon rate  and the bond sells at a discount. 77-7
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The Value of Financial Assets 0 1 2 N r% CF 1 CF N CF 2 Valu e ... 87-8
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Figure 7-1 97-9
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Other Types (Features) of  § 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  107-10
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§ The discount rate (ri) is the opportunity cost  of capital, and is the rate that could be earned  on alternative investments of equal risk. ri = r* + IP + MRP + DRP + LP
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Combined Chapter 7 - Chapter 7 Bonds and Their Valuation...

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