Chapter 7 - Bonds and Their Valuation Chapter 7 Key...

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Unformatted text preview: Bonds and Their Valuation Chapter 7 Key Features of Bonds Bond Valuation Measuring Yield Assessing Risk 7-1 What is a bond? A long-term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the holders of the bond. 7-2 Bond Markets Primarily traded in the over-the-counter (OTC) market. Most bonds are owned by and traded among large financial institutions. The Wall Street Journal reports key developments in the Treasury, corporate, and municipal markets. Online edition lists trading for each day the most actively-traded investment-grade, high-yield, and convertible bonds. 7-3 Key Features of a Bond Par value – face amount of the bond, which is paid at maturity (assume $1,000). Coupon interest rate – stated interest rate (generally fixed) paid by the issuer. Multiply by par value to get dollar payment of interest. Maturity date – years until the bond must be repaid. Issue date – when the bond was issued. Yield to maturity – rate of return earned on a bond held until maturity (also called the “promised yield”). 7-4 Effect of a Call Provision Allows issuer to refund the bond issue if rates decline (helps the issuer, but hurts the investor). Borrowers are willing to pay more, and lenders require more, for callable bonds. Most bonds have a deferred call and a declining call premium. 7-5 What is a sinking fund? Provision to pay off a loan over its life rather than all at maturity. Similar to amortization on a term loan. Reduces risk to investor, shortens average maturity. But not good for investors if rates decline after issuance. 7-6 How are sinking funds executed? Call x% of the issue at par, for sinking fund purposes. Likely to be used if r d is below the coupon rate and the bond sells at a premium. Buy bonds in the open market. Likely to be used if r d is above the coupon rate and the bond sells at a discount. 7-7 The Value of Financial Assets N N 2 2 1 1 r) (1 CF ... r) (1 CF r) (1 CF Value + + + + + + = 1 2 N r% CF 1 CF N CF 2 Value ... 7-8 Other Types (Features) of Bonds Convertible bond – may be exchanged for common stock of the firm, at the holder’s option. Warrant – long-term option to buy a stated number of shares of common stock at a specified price....
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Chapter 7 - Bonds and Their Valuation Chapter 7 Key...

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