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6–19 As a risk-averse investor, would you prefer bonds with short or long periods until maturity? Why?
6–20 What is a bond’s yield to maturity (YTM)? Briefly describe both the trialand-error approach and the use of a financial calculator for finding YTM. CHAPTER 6 Interest Rates and Bond Valuation 293 S U M M A RY
FOCUS ON VALUE
Interest rates and required returns embody the real cost of money, inflationary expectations, and issuer and issue risk. They reflect the level of return required by market participants as compensation for the risk perceived in a specific security or asset investment.
Because these returns are affected by economic expectations, they vary as a function of
time, typically rising for longer-term maturities or transactions. The yield curve reflects such
market expectations at any point in time.
The value of an asset can be found by calculating the present value of its expected cash
flows, using the required return as the discount rate. Bonds are the easiest financial assets to
value, because both the amounts and the timing of their cash flows are contractual and
therefore known with certainty. The financial manager needs to understand how to apply
valuation techniques to bonds, stocks, and tangible assets (as will be demonstrated in the
following chapters) in order to make decisions that are consistent with the firm’s share price
maximization goal. REVIEW OF LEARNING GOALS
Describe interest rate fundamentals, the term
structure of interest rates, and risk premiums.
The flow of funds between savers (suppliers) and
investors (demanders) is regulated by the interest
rate or required return. In a perfect, inflation-free,
certain world there would be one cost of money—
the real rate of interest. The nominal or actual interest rate is the sum of the risk-free rate, which is the
sum of the real rate of interest and the inflationary
expectation premium, and a risk premium reflecting
issuer and issue characteristics. For any class of
similar-risk securities, the term structure...
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