FMVCTopic 4a (appendix) - Interest Rate Theory and Bond Valuation [6-in-1]

FMVCTopic 4a (appendix) - Interest Rate Theory and Bond Valuation [6-in-1]

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1 6-1 Appendix More on provisions YTM and YTC Call provision Sinking fund provision 6-2 2 The Bond Indenture s Contract between the company and the bondholders and includes s The basic terms of the bonds s The total amount of bonds issued s A description of property used as security, if applicable s Sinking fund provisions s Call provisions s Details of protective covenants 6-3 3 Bond Characteristics and Required Returns s The coupon rate is usually set close to the yield, which depends on the risk characteristics of the bond when issued s Which bonds will have the higher yield, all else equal? s Secured debt versus a debenture s Subordinated debenture versus senior debt s A bond with a sinking fund versus one without s A callable bond versus a non-callable bond 6-4 Effect of a call provision s Allows issuer to refund the bond issue if rates decline (helps the issuer, but hurts the investor). s Borrowers are willing to pay more, and lenders require more, for callable bonds. s Most bonds have a deferred call and a declining call premium. 6-5 A 10-year, 10% semiannual coupon bond selling for \$1,135.90 can be called in 4 years for \$1,050, what is its yield to call (YTC)? s The bond’s yield to maturity can be determined to be 8%. Solving for the YTC is identical to solving for YTM, except the time to call is used for N and the call premium is FV. INPUTS OUTPUT N I/YR PMT PV FV 8 3.568 50 1050 - 1135.90 6-6 Yield to call s 3.568% represents the periodic semiannual yield to call. s

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This note was uploaded on 06/28/2010 for the course FINANCE FIN3410 taught by Professor On9 during the Spring '10 term at New England Conservatory.

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FMVCTopic 4a (appendix) - Interest Rate Theory and Bond Valuation [6-in-1]

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