BFIN620_PPT_CH5_sp09-7 - 5 1 Business Finance 620 Bond...

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5- 1 Bond Valuation Bond Valuation Chapter 5 Brealey-Myers-Marcus 5 th Edition Business Finance 620
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5- 2 Topics Covered Bond characteristics Basic terminology Bond yields Bond quotes Bond pricing techniques Coupon-paying bonds Bond risks Interest rate risk Default risk Other forms of corporate debt
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5- 3 Bond Terminology A bond represents a loan to a company. When you buy a bond, you are, in effect, loaning the company money. The bond indenture spells out the terms on which the loan is made. The bond legally obligates the issuing company to make certain payments to the bond buyers. The payments include periodic interest income and repayment of the amount loaned (principal) at the end of the loan (bond’s maturity).
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5- 4 Bond Terminology Coupon Dollar amount of interest paid to the bond owners at specific intervals Remains constant for the life of the bond Not all bonds pay coupons. Face Value Dollar amount loaned to the company, which must be repaid by the company at the bond’s maturity In effect, a bond’s price at both issue and maturity Also called the par value or maturity value
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5- 5 Coupon Rate and Bond Yields Coupon Rate The bond’s annual interest payment, expressed as a fixed percent of the bond’s face value Remains constant over the life of the bond. Not to be confused with the current yield or the yield to maturity. Current Yield The bond’s annual interest payment, expressed as a percent of the bond’s market price Annual return “at the moment” on the price paid for the bond, regardless of its maturity Can vary over the life of a bond
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5- 6 Coupon Rate and Bond Yields Yield To Maturity (YTM) Interest rate (discount rate) that equates the PV of a bond’s future cash flows (coupon payments and principal repayment) to its current price In effect, the average annual rate of return an investor can expect on the price paid for a bond today – if the bond is held to maturity Not to be confused with a bond’s coupon rate or its current yield Can vary over the life of the bond
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