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3. FIN 301-F08 Lab 3 Bonds

# 3. FIN 301-F08 Lab 3 Bonds - Corporate Debt Bonds...

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Corporate Debt: Bonds Session goals: Bond Valuation and Duration

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Bond Definitions Bond Par value (face value) Coupon rate Coupon payment Maturity date Yield or Yield to maturity 2
3 Bonds basics Issuer  borrower (corporations or government) Investor   lender = bondholder Face Value/Par Value (F)  =  the amount of the loan to the issuer.  It is to be paid back to the bondholder at maturity. Coupon Rate   (r )   = the promised annual rate of interest.  It is normally fixed at issuance for the life of the bond Interest is usually paid semiannually Maturity  = date on which the investor's principal will be repaid.  A bond does not have to be held to maturity; sell at any time. Yield to Maturity (YTM) :  market interest rate for bonds     Bonds =  fixed-income securities  (the cash flows are fixed)

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4 Bonds - Cash Flows Cash flows Annuity component (the coupons) Lump sum (the face value paid at maturity):    F= \$1,000 Pure discount (zero-coupon) bonds: no coupons    0        1         2              T-2       T-1       T C         C                C         C       C +\$1,000 ( 29 ( 29 T T r 1 1 F r 1 1 1 r C P + + + - =
5 Example of Coupon Payments (C) Example:  Semi-annual coupon  bond with  r =10%  year a   in   Coupons   of Frequency  Rate   Coupon  Value Face (C)   Coupon × =    0        1         2                T-2       T-1         T C         C                C         C       C+\$1,000 \$50 2 10% \$1,000 C = × =

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6 Bond Value Over Time After the bond is sold at face value, the discount rate  varies with the prevailing interest rate but coupon rates  are fixed. Consider a Telus bond with a 10% coupon rate After purchase of the bond, the interest rate on bonds  with similar risk increases to 11% As the discount rate increases the bond price  decreases and vice versa. Remember, higher discount  rate leads to lower present value. ( 29 ( 29 T T r 1 1 F r 1 1 1 r C P + + + - =
7 Valuation Example Consider a 15-year bond with 8% semi-annual  coupons and \$1,000 par value What will be the price of the bond if the discount rate is  6% (APR, compounded semiannually)?

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