7Interest Rates and Bond ValuationSlide 7- 1±ValuationThere are different types of investment, including bonds, stocks, and projects. All valuation problems are the same: Establishing the value today of future cash flows is the central problem of corporate finance.We’ll talk about bonds valuation first, which is the easiest.Valuation Problems
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Slide 7- 2±DefinitionA bond is a debt security that obligates the issuer (i.e., the seller) to make specified payments to the bondholder (e.g., the buyer). Bonds typically have the following characteristics:●Par value(or face value): The principal amount of a bond that is repaid at the end of the term. ●Coupon: The bondholder receives an interest payment each period until the bond matures, which are coupon payments.The annual coupon payment is determined as a percentage of face value. This percentage is the coupon rate.●Maturity: The specified date on which the principal amount of a bond is paid. ●Price: The amount the bondholder pay today to acquire the bond.Bond CharacteristicsSlide 7- 3±Bond Cash flowsCoupon payments (C) + Par value at maturity (Par):±Pricing a Bond: Two steps●Determine the cash flows (size and timing)●Calculate the aggregate present value of the cash flows.Bond Value = PV of coupons + PV of par(annuity) (lump sum)0123…CCCCtC + ParBond Valuation