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2504c_1004 - BUSI 2504c Essentials of Business Finance...

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Unformatted text preview: BUSI 2504c - Essentials of Business Finance Monday, October 4, 2010 §7 Bonds announcements • no lecture next week (Thanksgiving) • next class monday october 18 • quiz #2 monday october 18 • chapters 6 and 7 BUSI 2504c Monday, October 4, 2010 2 / 32 chapter 7: bonds • bond definitions • bond pricing • yield to maturity • zero-coupon bond • inflation and interest rate (incl. fisher effect) • term structure of interest rates BUSI 2504c Monday, October 4, 2010 3 / 32 7.1: bond definitions • Bond- long term debt instruments issued by corporations or governments • Coupons- regular interest payments made on a bond • Par value (face value)- principal amount of a bond that is repaid at the end of the term • Coupon rate- annual coupon payment(s) divided by par value • Maturity date- specified date at which the principal amount is repaid • Yield to maturity (YTM)- market interest rate that equates a bond’s PV of interest payments and PV of principal repayment with its price, ie. required market rate that makes the discounted cash flows from a bond equal to the bond’s price BUSI 2504c Monday, October 4, 2010 4 / 32 7.1: coupon bond BUSI 2504c Monday, October 4, 2010 5 / 32 7.1: bond prices • If YTM = coupon rate, then par value = bond price • Selling at par • If YTM > coupon rate, then par value > bond price • Selling at a discount, called a discount bond • If YTM < coupon rate, then par value < bond price • Selling at a premium, called a premium bond BUSI 2504c Monday, October 4, 2010 6 / 32 7.1: bond pricing equation Bond Value = PMT 1- 1 ( 1 + r ) t r | {z } present value of series of coupon payments (annuity) + FV ( 1 + r ) t | {z } present value of par (single lump sum) • Remember, as interest rates increase the PV’s decrease • So as interest rates increase, bond prices decrease and vice versa BUSI 2504c Monday, October 4, 2010 7 / 32 7.1: semiannual coupon bond - example • Most bonds in Canada make coupon payments semiannually. • Suppose you have an 8% semiannual-pay bond with a face value of $1,000 that matures in 7 years. If the yield is 10%, what is the price of this bond? • The bondholder receives a payment of $40 every six months (a total of $80 per year) • The market automatically assumes that the yield is compounded semiannually • The number of semiannual periods is 14 (7 years × 2 periods/year) answer : 40 PMT ; 14 N ; 5 I/Y ; 1000 FV ; CPT PV =-901.01 BUSI 2504c Monday, October 4, 2010 8 / 32 7.1: interest rate risk and time to maturity (figure 7.2, p.181)interest rate risk and time to maturity (figure 7....
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2504c_1004 - BUSI 2504c Essentials of Business Finance...

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