FM12 Ch 05 Show

FM12 Ch 05 Show - Chapter5 Bonds,BondValuation,and...

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  1 Chapter 5 Bonds, Bond Valuation, and  Interest Rates
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  2 Topics in Chapter Key features of bonds Bond valuation Measuring yield Assessing risk
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  3 Key Features of a Bond Par value:  Face amount; paid at  maturity. Assume $1,000. Coupon interest rate:  Stated interest  rate.  Multiply by par value to get dollars  of interest. Generally fixed. (More…)
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  4 Maturity:  Years until bond must be  repaid.  Declines. Issue date:  Date when bond was  issued. Default risk:  Risk that issuer will not  make interest or principal payments.
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  5 Call Provision Issuer can refund if rates decline.  That  helps the issuer but hurts the investor. Therefore, borrowers are willing to pay  more, and lenders require more, on  callable bonds. Most bonds have a deferred call and a  declining call premium.
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  6 What’s 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.
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  7 Sinking funds are generally  handled in 2 ways 1. Call x% at par per year for sinking  fund purposes. 2. Buy bonds on open market. Company would call if r d  is below the  coupon rate and bond sells at a  premium.  Use open market purchase if  rd is above coupon rate and bond sells  at a discount.
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  8 ( 29 ( 29 ( 29 PV = CF 1+r ... + CF 1+r 1 n 1 2 2 1 CF r n . 0 1 2 n r CF 1 CF n CF 2 Value ... + + + Financial Asset Valuation
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  9 Value of a 10-year, 10%  coupon bond if r d  = 10% ( 29 ( 29 V r B d = $100 $1,000 1 1 10 10 . . . + $100 1 + r d 100 100 0 1 2 10 10% 100 + 1,000 V = ? ... = $90.91 + . . . + $38.55 + $385.54 = $1,000. + + + 1 r + ( 29 d
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  10 10 10 100 1000 N I/YR PV PMT FV -1,000 $ 614.46 385.54 $1,000.00 PV annuity PV maturity value Value of bond = = = INPUTS OUTPUT The bond consists of a 10-year, 10% annuity of  $100/year plus a $1,000 lump sum at t = 10:
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  11 When r d rises, above the coupon rate, the bond’s value falls below par, so it sells at a discount. 10 13 100 1000 N I/YR PV PMT FV -837.21 INPUTS OUTPUT What would happen if expected inflation  rose by 3%, causing r = 13%?
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  12 What would happen if inflation  fell, and r d  declined to 7%? If coupon rate > r d , price rises above par, and bond sells at a premium. 10 7 100 1000 N I/YR PV PMT FV -1,210.71 INPUTS OUTPUT
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  13 Suppose the bond was issued 20 years  ago and now has 10 years to maturity.   What would happen to its value over  time if the required rate of return  remained at 10%, or at 13%, or at 7%?
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14 M 1,372 1,211 1,000 837 775 30 25 20 15 10 5 0 r d = 7%. r
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This note was uploaded on 02/07/2011 for the course MBA 6631 taught by Professor Fogelberg during the Spring '11 term at Troy.

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FM12 Ch 05 Show - Chapter5 Bonds,BondValuation,and...

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