Day 6-Part 1.2

Day 6-Part 1.2 - Day6:Part1 Chapter6:Part2BondValuation...

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Business Management 301 Day 6: Part 1 Chapter 6: Part 2—Bond Valuation July 7, 2011
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The Bond Indenture Bond Indenture:  The bond  contract . Three Main Components: 1) Lists all of the bond’s  features   (i.e.  coupon, par value, maturity,  convertibility, etc.) 2) Lists  covenants  which are designed to  protect bondholders. 3) Describes  repayment provisions .
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Bond Example Suppose our firm decides to issue  20-year  bonds  with a  par value of $1,000  and  annual coupon payments .  The return on  other bonds of similar risk is currently  12% so we decide to offer a  12% coupon   interest rate. What would be a fair price for these bonds?
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0 0        1        1       2       2       3       3       . . .         . . .        20      20 1000   120       120       120        . . .    120 P/YR = 1                       N = 20                           I/YR = 12                   FV = 1,000  PMT = 120  [0.12 x 1000 =  120] Solve PV =  -$1,000  Key Intuition :   If the coupon rate  = discount  rate , the bond will sell for par value .
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Our firm issued  20-year bonds  with a  par value of $1,000  and  annual coupon payments .  The return on other bonds of similar  risk at the time of issue was  12% , so we offered a  12% coupon   interest rate (thus we sold the bonds at par). Suppose  interest rates fall  immediately after we issue the 20-year  bonds.  The required return on bonds of similar risk drops to   10%. Question: What would happen to the bond price? Answer: When interest rates      bond prices     , but  by how much? Interest Rate      Impact on Price
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P/YR = 1                       Mode = End                  N = 20                           I/YR = 10%                  PMT = 120  [0.12 x 1000 = 120] FV = 1000 PV = ?  -$1,170.27              Key Intuition :   If the coupon rate  > discount rate the bond will sell for a premium . Premium Bond
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Our firm issued  20-year bonds  with a  par value of $1,000  and  annual coupon payments .  The return on other bonds of similar  risk at the time of issue was  12% , so we offered a  12% coupon   interest rate (thus we sold the bonds at par). Suppose  interest rates rise  immediately after we issue these bonds.   The required return on bonds of similar risk rises to  14% . Question: What would happen to the bond price?
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This note was uploaded on 11/17/2011 for the course BUS M 301 taught by Professor Jimbrau during the Summer '11 term at BYU.

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Day 6-Part 1.2 - Day6:Part1 Chapter6:Part2BondValuation...

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