BUS 420 Chapter_04

# BUS 420 Chapter_04 - Chapter 4 Chapter Bond Valuation 1...

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Chapter 4 Chapter 4 Bond Valuation 1

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Focus Areas Focus Areas Key features of bonds Bond valuation Measuring yield Assessing risk 2
Key Features of a Bond (a) Key Features of a Bond (a) Par value Coupon interest rate Maturity Issue date Default risk 3

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Call Provision (b) Call Provision (b) Rates declines. Borrowers vs. Lenders. Deferred calls Declining call premium. 4
What’s a sinking fund? (b) What’s a sinking fund? (b) 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. 5

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Financial Asset Valuation (c) Financial Asset Valuation (c) 6 ) ) PV = CF . . . + CF 1 N 2 (1 + r) 2 CF . 0 1 2 N r CF 1 CF N CF 2 Value ... + + (1 + r) 1 (1 + r) N
Value of a 10-year, 10% coupon Value of a 10-year, 10% coupon bond if r bond if r d d = 10% (d) = 10% (d) 7 100 100 0 1 2 10 10% 100 + 1,000 V = ? ... 10 10 100 1000 N I/YR PV PMT FV -1,000 INPUTS OUTPUT

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What would happen if expected inflation What would happen if expected inflation rose by 3%, causing r rose by 3%, causing r d = 13%? (e1) = 13%? (e1) 8 10 13 100 1000 N I/YR PV PMT FV -837.21 INPUTS OUTPUT
What would happen if inflation What would happen if inflation fell, and r fell, and r d d declined to 7%? (e2) declined to 7%? (e2) 9 10 7 100 1000 N I/YR PV PMT FV -1,210.71 INPUTS OUTPUT

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Bond Value (\$) vs Years Bond Value (\$) vs Years remaining to Maturity remaining to Maturity 10 M 1,372 1,211 1,000 837 775 30 25 20 15 10 5 0 r d = 7%. r d = 13%. r d = 10%.
What’s “yield to maturity”? YTM is the rate of return earned on a bond held to maturity. Also called “promised yield.” It assumes the bond will not default. 11

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## This note was uploaded on 02/14/2012 for the course BUS 420 taught by Professor Poindexter during the Spring '08 term at N.C. State.

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BUS 420 Chapter_04 - Chapter 4 Chapter Bond Valuation 1...

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