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MGMT310_lecture10

MGMT310_lecture10 - Lecture 10 Lecture 10 By now we know...

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Lecture 10 By now we know… Time value of money Need to compare cash flows from different points in time Annuities, Perpetuities, Growing Ann., Growing Perp. Special formulas for determining PV/FV of regular, periodic payments (or payments growing at a fixed rate) Effective interest rates How much interest are we really getting in a certain time period? Appropriate discount rates depending on frequency of CF’s Appropriate discount rates depending on frequency of CF s Are we receiving cash flows monthly, semi annually, annually, etc.? Now let’s apply these concepts to bond (ch.7) and stock (ch.8) valuation!
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Bonds Bond : a loan made by investors to the issuer . In return for his/her money, the investor receives a legaI claim on future cash flows of the issuer. The issuer promises to: Make regular coupon payments every period until the bond matures Pay the face/par/maturity value of the bond when it matures. Default since bonds are contractual obligations , an issuer who fails to keep them is subject to legal action on behalf of the lenders (bondholders) (bondholders).
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Let’s learn some bond features Bonds (that pay coupons) typically make semi annual coupon payments 1. If a bond has a $1000 face value, five years to maturity, and a coupon rate of 8%, what would its cash flows look like? 2. How much is this bond worth if the yield to maturity is quoted at 10%? (Note: as w/ APRs, the quoted yield is equal to the actual rate per period multiplied by the number of periods) 3. What is the effective annual yield/rate on this bond? 4. Is this bond selling at par value , at a premium , or at a discount ?
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Bond pricing equation T T F 1 1 r Price = C + 1+ r r = PV of coupons + PV of face val e u where: C = coupon payment F = face value T = number of periods until maturity T number of periods until maturity r = required rate of return (per period)
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Bond rates and yields Coupon rate Annual coupon amount expressed as a percentage of the face value Current yield Annual coupon amount divided by the current market price of the bond i ld i ( ) Yield to maturity (YTM) Rate required in the market on a bond Do not confuse current yield w/ YTM !!
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Bond rates and yields: Example 1. Suppose a bond currently sells for $932.90. It pays a semi annual coupon of $35, and it matures in 10 years. It has a face value of $1000. What are
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