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Chapter 7 - CHAPTER7 Keyfeaturesofbonds Bondvaluation...

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7-1 CHAPTER 7 Bonds and Their Valuation Key features of bonds Bond valuation Measuring yield Assessing risk
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7-2 Corporate Financing Mix First Principles Invest in projects that yield a return greater than the minimum  acceptable hurdle rate. The hurdle rate should be higher for riskier projects and reflect the financing  mix used - owners’ funds (equity) or borrowed money (debt) Choose a financing mix that minimizes the hurdle rate and matches the  assets being financed. If there are not enough investments that earn the hurdle rate, return the  cash to stockholders. The form of returns - dividends and stock buybacks - will depend upon the  stockholders’ characteristics. Objective: Maximize the Value of the Firm
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7-3 Corporate Financing Mix The Choice in Financing: There are only two ways in which a business can make money. • The first is debt. The essence of debt is that you promise to make fixed  payments in the future (interest payments and repaying principal). If you fail to  make those payments, you lose control of your business. • The other is equity. With equity, you do get whatever cash flows are left over  after you have made debt payments. The equity can take different forms: For very small businesses: it can be owners investing their savings For slightly larger businesses: it can be venture capital For publicly traded firms: it is common stock The debt can also take different forms For private businesses: it is usually bank loans For publicly traded firms: it can take the form of bonds
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7-4 Corporate Financing Mix
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7-5 Measuring a firm’s financing  mix The simplest measure of how much debt and equity a  firm is using currently is to look at the proportion of debt  in the total financing. This ratio is called the debt to  capital ratio:   Debt to Capital Ratio = Debt / (Debt + Equity) Debt includes all interest bearing liabilities, short term as well  as long term. Equity can be defined either in accounting terms (as book  value of equity) or in market value terms (based upon the  current price). The resulting debt ratios can be very different.
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7-6 Costs and Benefits of Debt Benefits of Debt Tax Benefits Adds discipline to management Costs of Debt Bankruptcy Costs Agency Costs Loss of Future Flexibility
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7-7 What managers consider important in  deciding on how much debt to carry...
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