361-CH7Concise - 7-1CHAPTER 7Bonds and Their Valuation...

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Unformatted text preview: 7-1CHAPTER 7Bonds and Their Valuation Updated: January 23, 2012Key features of bondsBond valuationMeasuring yieldAssessing risk7-2What 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.7-3Bond marketsPrimarily traded in the over-the-counter (OTC) market.Most bonds are owned by and traded among large financial institutions.Full information on bond trades in the OTC market is not published, but a representative group of bonds is listed and traded on the bond division of the NYSE.7-4Key Features of a BondPar 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”).7-5Effect of a call provisionAllows issuer to refund the bond issue if rates decline (helps the issuer, but hurts the investor).Borrowers are willing to pay a higher interest rate, and lenders/investors require a higher rate, for callable bonds.Most bonds have a deferred call and a declining call premium.7-6What 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.7-7How are sinking funds executed?Call x% of the issue at par, for sinking fund purposes.Likely to be used if rd is below the coupon rate and the bond sells at a premium.Buy bonds in the open market.Likely to be used if rd is above the coupon rate and the bond sells at a discount.7-8The value of financial assetsNN2211r)(1CF ... r)(1CF r)(1CF Value++++++=12Nr%CF1CFNCF2Value...7-9Other types (features) of bondsConvertible 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.Putable bond – allows holder to sell the bond back to the company prior to maturity....
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This note was uploaded on 01/23/2012 for the course BUS 361 taught by Professor Staff during the Fall '11 term at University of Michigan.

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361-CH7Concise - 7-1CHAPTER 7Bonds and Their Valuation...

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