8_Bonds - Agenda 1. 2. 3. 4. 5. 6. Accounting for Bonds...

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Agenda 1. Accounting for Bonds 2. Early Retirement 3. Retirement at Maturity 4. Financial Statement Effects of Bond Transactions 5. Financial Statement disclosures 6. Take-Aways
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What is a bond? A bond is a certificate showing evidence of debt. (legal agreement) Companies and Governments issue bonds to investors to raise capital A bond specifies: how much will be repaid at maturity (Par value or Principal or Face Value) Interest Payments ( Called Coupons ) Date of maturity (or repayment) Other possible features – convertible, callable etc Hence most bonds have 2 components, a lump sum payment and an annuity of interest payments.
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Bonds Generally - Bonds issued by the firm are valued on the balance sheet (book value or carrying value) at their present value using the market interest rate prevailing at time of issuance as the discount rate. Note: The bond’s coupon rate and market rate may differ
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Market Rate Yield Curve U.S. Government Benchmark Debt Ratings – Corporate Appropriate spreads (correlated with default risk)
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Yield Curve Treasury yields vary with the maturity of the security, generally increasing as the term increases.
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Debt Ratings and the Cost of Debt Yield Rate = Risk-Free Rate + Spread The market rate of interest used to price our bonds. Yield on U.S. government borrowings such as treasury bills, notes, and bonds. The risk premium.
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Debt Ratings and the Cost of Debt Here are the descriptions given to the risk of bonds by the three major bond rating services. AAA is the top rating and D bonds are generally considered to have the most risk.
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Debt Ratings and the Cost of Debt The rate of interest that a company must pay on its debt is a function of the maturity of that debt and the creditworthiness of the issuing company. Bond Risk Rating
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Calculating the NBV of Bonds $1,000 Face, 10-year bond issued at par, at a premium and at a discount ( interest payments are semi-annual - so payment every 6 months is $1000 x 6%=$60, n=20 since 10yrs but semi-annual means 2x10 periods) : Premium Par Discount coupon rate: 12% 12% 12% market rate: 10% 12% 14% PV: 1,124.62 1,000 894.06
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Calculating the NBV of Bonds Premium : Principal: 1,000/( 1.05 20) = 376.89 Interest : 60 * [1 – ( 1.05 ) -20] = 747.73 . 05 1,124.62 Premium = 1124.62 – 1000 (Face) = 124.62 Par : Principal: 1,000/( 1.06 20) = 311.80 Interest 60 * [1 – ( 1.06 )-20 ] = 688.20 . 06 1,000.00 (Face) Discount : Principal: 1,000/( 1.07 20) = 258.42 Interest 60 * [1 – ( 1.07 ) -20] = 635.64 . 07 894.06 Discount = 1000 (Face) – 894.06 = 105.94
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This note was uploaded on 10/17/2011 for the course MGMT 600 taught by Professor Johnston during the Spring '11 term at Purdue University-West Lafayette.

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8_Bonds - Agenda 1. 2. 3. 4. 5. 6. Accounting for Bonds...

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