L3 - Lecture 3 Interest Rates and Bond Valuation Key...

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Lecture 3 Interest Rates and Bond Valuation
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3-2 Key Concepts and Skills Know the important bond features and bond types Understand bond values and why they fluctuate Understand the term structure of interest rates
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3-3 Lecture outline Key Features Of Bonds Bond Valuation Bond Risk Measures Bond Return Measures Term Structure of Interest Rates Yield Curve
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3-4 What Is a Bond? A long-term debt instrument in which a bond issuer promises to pay the bond holders periodic interest payments and a face/par value when it matures. Issuer of Bonds Treasury Corporate Municipal Foreign              Int.      Int.      Int.           Int.+Principal      0        1         2        3    ………          N
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5 Differences Between Debt and Equity Debt Not an ownership Creditors do not have voting rights Interest is considered a cost of doing business and is tax- deductible Creditors have legal recourse if interest or principal payments are missed Excess debt can lead to financial distress and bankruptcy Equity Ownership Common stockholders vote to elect the board of directors and on other issues Dividends are not considered a cost of doing business and are not tax deductible Dividends are not a liability of the firm until declared. Stockholders have no legal recourse if no dividends are declared An all-equity firm cannot go bankrupt
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6 The Bond Indenture Contract between the company and the bondholders and includes The basic terms of the bonds The total amount of bonds issued A description of property used as security, if applicable Repayment: Sinking fund provisions Call provisions Details of protective covenants
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3-7 Basic terms of a Bond Par value: face amount of the bond, which is paid at maturity (normally $1,000). Coupon interest rate : the stated interest rate (generally fixed) paid that times the par value to get the periodic interest payments. Maturity date : when the bond will be repaid. Time to maturity is the time period between now to the maturity date.
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3-8 Other Features Registered vs. Bearer Forms Security Collateral – secured by financial securities Mortgage – secured by real property, normally land or buildings Debentures – unsecured Notes – unsecured debt with original maturity less than 10 years
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