Unformatted text preview: hat mechanisms protect bondholders? CHAPTER 6 Interest Rates and Bond Valuation 281 6–7 Differentiate between standard debt provisions and restrictive covenants
included in a bond indenture. What are the consequences of violation of
them by the bond issuer?
6–8 How is the cost of bond financing typically related to the cost of shortterm borrowing? In addition to a bond’s maturity, what other major factors affect its cost to the issuer?
6–9 What is a conversion feature? A call feature? Stock purchase warrants?
6–10 What information is found in a bond quotation? How are bonds rated,
6–11 Compare the basic characteristics of Eurobonds and foreign bonds. LG4 6.3 Valuation Fundamentals valuation
The process that links risk and
return to determine the worth of
an asset. Valuation is the process that links risk and return to determine the worth of an
asset. It is a relatively simple process that can be applied to expected streams of
benefits from bonds, stocks, income properties, oil wells, and so on. To determine an asset’s worth at a given point in time, a financial manager uses the timevalue-of-money techniques presented in Chapter 4 and the concepts of risk and
return developed in Chapter 5. Key Inputs
There are three key inputs to the valuation process: (1) cash flows (returns), (2)
timing, and (3) a measure of risk, which determines the required return. Each is
described below. Cash Flows (Returns)
The value of any asset depends on the cash flow(s) it is expected to provide over
the ownership period. To have value, an asset does not have to provide an annual
cash flow; it can provide an intermittent cash flow or even a single cash flow over
EXAMPLE Celia Sargent, financial analyst for Groton Corporation, a diversified holding
company, wishes to estimate the value of three of its assets: common stock in
Michaels Enterprises, an interest in an oil well, and an original painting by a wellknown artist. Her cash flow estimates for each are as follows:
Stock in Michaels Enterprises Expect to receive cas...
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