Chapter 5. Valuing long-term debt

Chapter 5. Valuing long-term debt - Valuing long-term debt...

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Valuing long-term debt Chapter 5 Finance 357
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A Typical Bond IBM wants to borrow $1000 and would like to repay the $1,000 in 30 years. The interest rate on debt from similar companies is 6% per year. 6% X $1,000 = $60 interest payment per year for 30 years. A $1,000 payment will be made at the end of 30 years to repay the loan.
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Bond Terminology Bond payments are called Coupons The amount to be repaid at the end of the loan is the Face Value or Par Value Annual coupon divided by the face value is the Coupon Rate The number of years until the face value is repaid is called the time to Maturity. As each year passes, the time to maturity decreases by one year
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IBM Bond using Bond Terminology IBM wants to borrow $1000 and would like to repay the $1,000 in 30 years. The interest rate on debt from similar companies is 6% per year. Becomes A 30 year IBM bond with a $1,000 face value and a 6% coupon rate. The time to maturity is 30 years.
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Bond Values and Yields Over time, market interest rates change but the coupon on bonds remain the same. This causes the present value of bonds to fluctuate. As market interest rates rise, the present value of bonds fall. When interest rates fall, the present value of bonds rise. To determine the value of a bond once it has been issued, we need the time remaining till maturity, the face value, the coupon and the market interest rate for bonds with similar features.
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Bond Values and Yields (con’d) The interest rate that is required by the market after a bond has been issued is its Yield to Maturity . Sometimes it is just called Yield . To value a bond we need: Time till maturity Face value Coupon Market interest rate for bonds with similar features.
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Valuing a Bond IBM issues a 10 year $1,000 bond with an annual coupon of 8%. The yield to maturity on this bond is 8%. Present Value of Face repayment = $1,000/ 2.1589 = $463.19 Annuity Present Value = $80 X (1 – 1/1.08 10 ) / .08 = $536.81 Total Bond Value = $463.19 + $563.81 = $1,000
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Bond Premium vs Discount A bond that is selling for it’s face value is often said to be selling at par . ($1000 face bond selling for $1000) A bond selling for more than its face value is said to be selling at a premium . ($1000 face bond selling for $1100) A bond selling for less than its face value is said to be selling at a discount . ($1000 face bond selling for $900)
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Bond Valuation Formula A formula combining both the present value of the face value and an annuity of the coupon payments can be used to value a bond.
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Bond Valuation General Electric issued a bond several years ago. This bond has a face value of $1,000 with a $60 annual coupon. There are 23 years left until the bond matures. What is the present value of the bond if current interest rates are 5%?
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General Electric Bond Value General Electric issued a bond several years ago. This bond has a face value of $1,000 with a $60 annual coupon. There are 23 years left until the bond matures. What is the present value of the bond if current
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This note was uploaded on 11/09/2010 for the course FIN 357 taught by Professor Hadaway during the Spring '06 term at University of Texas at Austin.

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Chapter 5. Valuing long-term debt - Valuing long-term debt...

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