Chapter_6_Fall2011_s

# Chapter_6_Fall2011_s - Chapter61 Chapter...

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1 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 6 Interest Rates and Bond Valuation Elizabeth Booth Chapter 6 Interest Rates and Bond Valuation

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2 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 6 Interest Rates and Bond Valuation Elizabeth Booth Key Concepts and Skills Know the important bond features and bond types Understand bond values and why they fluctuate Understand bond ratings and what they mean Understand the impact of inflation on interest rates Understand the term structure of interest rates and the determinants of bond yields Use time value of money techniques to evaluate bonds (discounted cash flow methodology)
3 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 6 Interest Rates and Bond Valuation Elizabeth Booth Bond Terminology Bond Par value (face value) typically \$1,000 Coupon rate stated in the indenture (contract) Coupon payment (Pmt) calculated based on the coupon rate (Coupon Rate)*(Face Value)/(#of payments per year) Maturity number of periods before end of the contract’s life Yield or Yield to maturity (YTM) bond’s market rate

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4 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 6 Interest Rates and Bond Valuation Elizabeth Booth Bond Values and Yields The market price of a bond is calculated by discounting the interest payments (coupons) and face value at the current market rate . The Yield to Maturity (YTM) of a bond is the current market rate of return on a bond. It is the rate that makes the PV of future cash flows equal to current price. If a bond sells at face value, its YTM is equal to its coupon rate.
5 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 6 Interest Rates and Bond Valuation Elizabeth Booth Basic Bond Valuation Model PV of an annuity, where PMT=coupon payment  n n i Par i i PMT P 1 1 1 1 1 0 PV of a future cash flow. The bond issuer repays the par value at maturity i = discount rate

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6 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 6 Interest Rates and Bond Valuation Elizabeth Booth Present Value of a Bond: Company Alpha issues a 20 year bond with annual payments. The face value of the bond is \$1,000 and the coupon rate is 5%. If the current market rate of return is 8%, what is the price of the bond? 1. Remember that the price of the bond is the PV of the related stream of cash flows 2. The cash flows generated by the bond are fixed (written in a contract) and of two types: Coupon payments (calculated based on the coupon rate) Face value (typically \$1,000) 3. Remember also that you can add, subtract and compare values that are related to the same period of time (e.g. Time 0 Present value)
7 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 6 Interest Rates and Bond Valuation Elizabeth Booth

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## Chapter_6_Fall2011_s - Chapter61 Chapter...

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