fi3131chp7_student - FINC3131 Business Finance Chapter 7...

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1 FINC3131 Business Finance Chapter 7: Bonds and Their Valuation
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2 Learning objectives 1. Compute the price of a consol 2. Compute the price of a zero-coupon bond. 3. Compute the price of a fixed-coupon bond.
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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.
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Key Features of a Bond 1. Par value – face amount of the bond, which is paid at maturity (assume $1,000). 2. Coupon interest rate – stated interest rate (generally fixed) paid by the issuer. Multiply by par value to get dollar payment of interest. 3. Maturity date – years until the bond must be repaid. 4. Issue date – when the bond was issued. 5. Yield to maturity - rate of return earned on a bond held until maturity.
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5 Bond Types 1. Consols, 2. Zero-coupon bonds 3. Fixed-coupon bonds
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Other types (features) of bonds 1. Convertible bond – may be exchanged for common stock of the firm, at the holder’s option. 2. Warrant – long-term option to buy a stated number of shares of common stock at a specified price. 3. Putable bond – allows holder to sell the bond back to the company prior to maturity. 4. Income bond – pays interest only when interest is earned by the firm. 5. Indexed bond – interest rate paid is based upon the rate of inflation.
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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% CF 1 CF N CF 2 Value ...
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8 Consols 1 1. Pays a fixed coupon every period forever. 2. Has no maturity. 3. Investor who buys a consol is buying the perpetuity of the fixed coupon. So, use PV formula of a perpetuity to find the present value/price of the consol Price of consol = consol on return of rate required s investor' dollars in coupon fixed
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9 Consols 2 Remember earlier that cost of capital = investor’s required rate of return. So, we can re-arrange the equation to find the firm’s cost of consol capital. Cost of consol capital consol of price dollars in coupon fixed =
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Consol problem 1 ABC Corp. wants to issue perpetual debt in order to raise capital. It plans to pay a coupon of $90 per year on each bond with face value $1,000. Consols of a comparable firm with a coupon of $100 per year are selling at $1,050. What is the cost of debt capital for ABC? What will be the price at which it will issue its consols? 1.
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fi3131chp7_student - FINC3131 Business Finance Chapter 7...

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