Class 7

# Class 7 - o Bond ratings Problem is that rating agencies...

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Ch. 9: Debt Valuation and Interest Rates Corporate borrowings: o Loans from financial institution is private debt (smaller firms) o Bonds are public debt (larger firms) o LIBOR: Inter-bank interest rate on loans 100 basis points is 1% Max./ min. rate equals ceiling/ floor Use LIBOR (t-1) plus spread o Prime: Rate which banks offer to best customers o Selling of debt securities (i.e. mutual funds): Corporate bond: Indenture: o Leal agreement on terms of loan Par value (principal face): o Face value of bond Current yield (not the YTM): o Annual int. payment/ current market price of bond Call provision: o Issuer of bond has right to buy back bonds and no longer pay high interest rate Conversion feature: o Allows bondholders to convert bond into equity/ shares of common stock

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Unformatted text preview: o Bond ratings: Problem is that rating agencies get paid by firms issuing the bonds Probability that a firm will default on bond Lower the rating, higher the risk of default, higher the rate of return demanded by bondholders (higher yield) o Valuing corporate debt: Present value of contractually promised cash flows YTM: • 0 = -Price + int./ (1+r)^1 + … + principal/ (1+r)^N • Use Excel GoalSeek or RATE function for simple cases o Only works w/ consistent interest payments Discount bond: • YTM is larger than coupon rate Market yields: • Quoted in terms of credit spreads or spreads to Treasury bonds...
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Class 7 - o Bond ratings Problem is that rating agencies...

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