7
Interest Rates and
Bond Valuation
Slide 7- 1
±
Valuation
There 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
±
Definition
A 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 Characteristics
Slide 7- 3
±
Bond Cash flows
Coupon 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)
0
1
2
3
…
C
C
C
C
t
C + Par
Bond Valuation