Chapter 5 - Chapter 5 Introduction to the Valuation of Debt...

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1 Chapter 5 – Introduction to the Valuation of Debt Securities 1. Fundamental principles of bond valuation: 1. estimate the expected cash flows 2. determine the appropriate interest rate (or rates) to use to discount the cash flows 3. calculate the PV of the expected cash flows when discounted with appropriate interest rate 2. Difficulty in estimating cash flow for the following types of securities 1. The issuer (call option) or the investor (put option) has the option to change the contractual due date of the repayment of the principal (ex,. MBS, ABS, Callable and Putable bonds) 2. The coupon payment is reset periodically (floating rate) based on a formula that depends on some value or values for reference rates, prices, or FX rate, or 3. The investor has the choice to convert or exchange that security into common stock. 3. Appropriate interest rate for valuing a corporate bond’s cash flow, is a 2 step process: 1. The minimum interest rate needed is the yield of the on-the-run treasury with same
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Chapter 5 - Chapter 5 Introduction to the Valuation of Debt...

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