Lec2 - Lecture 2 page 8 REVIEW OF BASIC FINANCIAL...

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Lecture 2 page 8 R EVIEW OF B ASIC F INANCIAL I NSTRUMENTS : Debt and Equity What is a financial instrument ( security )? A legal agreement representing a claim by the holder on the issuer. e.g. debt (bond) and equity (stock) Debt Debt: What is it? A loan , IOU Like any loan, there are contractual elements to any debt instrument: IRS Definition 1. promise to repay interest and principal 2. fixed maturity date 3. “fair” market rate of interest 4. debtholders cannot also be significant equityholders (Agency problems) Who issues bonds? Treasury bonds – U.S. government. Default “risk free”. Still has interest rate risk. Corporate bonds- Many different risk levels. Municipal bonds – (munis) state and local government. No federal tax. Foreign bonds – bonds from foreign corporations and governments. - Richard T. Bliss, Babson University and Terry D. Nixon, Miami University
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Lecture 2 page 9 Types of debt instruments bills – mature in less than one year from date of initial issuance notes – one to ten years bonds – more than ten years Why would an investor buy debt securities? That is, why would one lend money to a firm? Buying “certainty” of cash flows (cf). Default risk is still present. Buyer exchanges cash today for future CFs. How would we determine the value of any debt instrument?
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Lec2 - Lecture 2 page 8 REVIEW OF BASIC FINANCIAL...

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