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Fin 101 Bond Review

Fin 101 Bond Review - Fin 101 Corporate Bonds Review In...

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Fin 101 – Corporate Bonds Review In this section of the Finance Review Packet, some characteristics of corporate bonds will be described. And, Time Value of Money will be used to compute a bond’s value. The section ends with some practice problems. If you have any questions about the content of this chapter, refer to chapter 5 in the Beasley and Brigham textbook. Bond Characteristics Basic Characteristics and Terms When corporations borrow money, one option available is to raise a large sum of cash (capital) in the debt markets via a bond issue. Bonds are sold to investors who become the company’s creditors. The total amount borrowed is broken down into pieces; each piece is called a Bond . The dollar value of each piece is the bond’s Face Value . Bonds generally trade in multiples of $1000, although it is not necessary that they do so. Assuming that a company’s bond issue is in multiples of $1000, a firm that wants to raise $100,000,000 via a bond issue would issue 100,000 bonds each with a face value of $1000. If bonds the bonds were issued in multiples of $100,000, the company would issue 1000 bonds. Bonds, like other loans, are repaid at during a fixed time period. The time period’s end is the bond’s maturity. Every bondholder will be entitled to cash interest throughout the bond’s life and a single payment equal to the bond’s face value when it matures. Cash interest, called coupon interest , is paid semi-annually throughout the bond’s life. The cash interest payment, the bond’s face value and its maturity are generally fixed on the bond’s issue date. As a rule, these three characteristics cannot be changed while the bond is outstanding. If for some reason, prior to the bond’s maturity, the issuer has financial problems and is unable to pay its bills, the bondholder receives first priority , with regard to receiving any money owed to her. This mean she is paid before the preferred stock holders and common stockholders receive any cash from the firm. A Bond’s Cash Flows An investor who purchases the bond in October 2008 will be lending money to Dillon Corporation. In exchange for making the loan, the investor will receive a semi-annual cash Dillon Corporation plans to raise $1,000,000 via a debt issue. The company plans to sell 1000 bonds with a face value of $1000. The bonds will be issued in October 2008. Bond holders will receive coupon interest of 4.5% in April and October of each year beginning in April 2009. The bonds will mature in October 2038. Finance Department 2008 Page 2
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payment (coupon interest) and at the end of the bond’s life repayment of the loan’s principal (Face Value). The bond’s cash interest will equal: [.045/2]*$1000 = $22.5 the (annual coupon rate/2)* Face Value ( Note the coupon rate must be converted to decimals) A total of 60 coupon payments will be made. When the bond matures in October 2038, the bondholder will receive a single payment of $1000 for each bond that s/he owns.
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Fin 101 Bond Review - Fin 101 Corporate Bonds Review In...

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