03A Fin 301 Bond valuation Ulearn

03A Fin 301 Bond valuation Ulearn - Valuing Debt Debt

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Valuing Debt
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2 Debt § Debt: contract explicitly spells out § What cash flows will be received § When they will take place § Interest payments are § Tax deductible by the firm § Fully taxable to the recipient § Debt holders have priority claim on a firm's  cash flow
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3 More on Bonds § Registered versus Bearer § Bearer bonds are gone if lost § Holders of bearer bonds will not be notified of  changes in corporate policies § However, bearer bonds have lower transaction  costs
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4 And Yet More § Debenture § Subordinate (“Junior Debt”) § Callable § Retractable § Convertible § Zero coupon § Floating rate § Income Bonds
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5 Wait, there’s more… § Bond Covenants § Negative § Positive § Repayment provisions § Sinking Fund § Bond characteristics, bond yields and  prices § Prices are “stale” § www.canpx.ca
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6 Almost done… Default Risk and Bond Ratings § § Rating reflects ability to pay § Likelihood of timely repayment § BBB or better for investment grade § Firms provide info, so only as good as  what is disclosed § What should happen to a bond’s price if  the bond is downgraded? § Unrated debt (a.k.a. Junk Bonds)
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7 Discount Loans § Simplest loan § Borrower gets  $ X   today § Repays interest and principle in single payment  § Borrow $683 for 4 years at 10%. Repayment: 0 . 000 , 1 $ ) 10 . 1 ( 683 $ 4 = × § Face value usually specified - borrower  receives discounted value. Treasury Bill ( r  =  5%, T = 1): 95 . 380 , 952 $ 05 . 1 000 , 000 , 1 $ = Government  borrows Government will  repay
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8 Amortized Loans (1) § Each period you pay interest and repay some  § Usually an annuity: stream of even payments § Borrow $100 for five years at 10% § Repay in equal installments: ( 29 38 . 26 $ 79 . 3 100 $ 79 . 3 1 . 0 1 1 1 1 . 0 1 100 $ 5 = = × = + - × = C C C
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9 Amortized Loans(2) OWE PAY Interest Principal New Balance 1 100.00 26.38 10.00 16.38 83.62 2 83.62 26.38 8.36 18.02 65.60 3 65.60 26.38 6.56 19.82 45.78 4 45.78 26.38 4.58 21.80 23.98 5 23.98 26.38 2.40 23.98 0.00
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10 Interest Only Loans § Most corporate bonds make semiannual payments § Five year maturity means that no. of periods = 10 1 2 3 4 5 $100 $100 $1,00 0 $10 0 $10 0 $100 0 – $1,000 § Principal is re-paid in a single ( bullet ) payment when the loan expires  (corporate bonds) § For example, if the interest rate is 10% (lender’s perspective):
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03A Fin 301 Bond valuation Ulearn - Valuing Debt Debt

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