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ActSc371_Lecture 10_Chapter 6 (Ross)_updated - Copy

# ActSc371_Lecture 10_Chapter 6 (Ross)_updated - Copy - ActSc...

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Lecture 10 Sections 6.1 - 6.3 : How to Value Bonds and Stocks (Corporate Finance by Ross et al.) ActSc 371 – Corporate Finance 1 Instructor: Dr. Lysa Porth 1

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Introduction How to Value Bonds and Stocks 6.1 Definition and Example of a Bond 6.2 How to Value Bonds 6.3 Bond Concepts 2
3 6.1 Definition and Example of a Bond Bond: Certificate showing that a borrower owes a specified sum. In return for borrowing the money, the borrower has agreed to make interest and principal payments on the designated dates. Example: Krueger Enterprises issued 100,000 bonds for \$1,000, each with a coupon rate of 5% and a maturity of 2 years. Interest is paid annually. How much as the firm borrowed? 100,000x\$1,000=\$100 million How much interest must the firm pay? \$100 million x 5% = \$5 million at the end of one year. How much does the firm have to repay at the end of two years? Both the \$5 million interest, plus the \$100 million.

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Valuation of Bonds and Stock Think of a bond like this… A bond is a kind of loan, but with a difference. With a normal loan, you borrow a certain amount at some interest rate, and calculate how much must be paid in the future. With a bond however, you set the amount that is to be repaid in the future (that’s the face value), and then calculate the amount that you get to borrow today (that’s the price). The coupon payments are the interest. The principal is received in a lump sum at the end. This is important because as interest rates change over time, than so does its price. This allows “loans” (in the form of bonds) to be bought and sold in a market, called the bond market.
6.1 Definition and Example of a Bond Consider a Government of Canada bond listed as 5.000 December 2018. The Par Value of the bond is \$1,000. Coupon payments are made semi-annually (June 30 and December 31 for this particular bond). Since the coupon rate is 5.000 the payment is \$25.000. On January 1, 2012 the size and timing of cash flows are: 12 / 1 / 1 25 \$ 12 / 30 / 6 25 \$ 12 / 31 / 12 25 \$ 18 / 30 / 6 025 , 1 \$ 18 / 31 / 12

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Face value = \$1000; 10 year term; Coupon Rate = 6.25 % paid semi-annually; Price = \$857.67; Yield-to-maturity = 8.38 %. 1) The FACE VALUE ( FV ) : The face value for almost any bond is \$1000, but it can vary. This is the amount that must be paid to the owner of the bond upon maturity. Example
2) The coupon ( C ): The coupon is the interest payment that is made at regular intervals to the owner of the bond. As such, it can be treated as an annuity. The value of the coupon is determined by the coupon rate . The coupon rate is stated as an annual rate that is compounded as often as the coupon is paid every year. Most bonds pay coupons twice a year, but any payment frequency is possible. To find the coupon, divide the stated rate by the number of times the coupon is paid every year, and multiply it by the face value . From the example: So the bond pays a coupon of \$31.25 every six months Example Cont’d 03125 . 0

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ActSc371_Lecture 10_Chapter 6 (Ross)_updated - Copy - ActSc...

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