6thCh7P - CHAPTER7 BondsandTheirValuation...

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1 CHAPTER 7 Bonds and Their Valuation Key features of bonds Bond valuation Measuring yield Assessing risk
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2 7-2 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. Treasury - government bonds - no default risk US Treasury bonds are NOT the Savings Bonds that  you received for high school graduation. Agency - quasi government Corporate bonds Muni (municipal) bonds Foreign bonds
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3 7-3 Bond Markets Primarily traded in the over-the-counter  (OTC) market. Most bonds are owned by and traded  among large financial institutions. The Wall Street Journal  reports key  developments in the Treasury, corporate,  and municipal markets.  Online edition  lists trading for each day the most  actively-traded investment-grade, high- yield, and convertible bonds.  http:// online.wsj.com/mdc/public/page/mdc_bonds.html?mod =mdc_topnav_2_3000 
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4 Bond Terminology Par value, face value, principal amount Coupon interest rate, coupon payment Maturity Issue date, settlement date Call provision Bond rating, bond rating agency
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5 Financial Asset Values ( 29 ( 29 ( 29 PV = CF 1+r ... + CF 1 n 1 2 2 1 CF r n . 0 1 2 n k CF 1 CF n CF 2 Value ... + + +
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6 What is the opportunity cost of debt  capital? The discount rate (k ) is the  opportunity cost of capital, and is the  rate that could be earned on  alternative investments of equal risk. r i  = r* + IP + MRP + DRP + LP
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7
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8 Time Line Coupon Interest Par Value 0 Jan. 1, 1863 1 July 1, 1863 20 2 Jan. 1, 1864 20 3 July 1, 1864 20 4 Jan. 1, 1865 20 5 July 1, 1865 20 6 Jan. 1, 1866 20 7 July 1, 1866 20 8 Jan. 1, 1867 20 9 July 1, 1867 20 10 Jan. 1, 1868 20
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9 Using a financial calculator to  value a bond This bond has a $500 lump sum due at t = 5,  and semi annual $20 coupon payments  beginning at t = 1 and continuing through t = 5,  the price of the bond can be found by solving for  the PV of these cash flows. The yield is 8%.
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6thCh7P - CHAPTER7 BondsandTheirValuation...

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