The document discusses bonds and their valuation. There are several types of bonds including treasury bonds, corporate bonds, municipal bonds, and foreign bonds. Key characteristics of bonds include the par value, coupon interest rate, maturity date, call provisions, and sinking fund provisions. Bond prices are affected by interest rate changes which can create price risk and reinvestment risk for bondholders. The value of a bond is calculated based on the present value of its future cash flows, discounted at the current market rate of interest.
The document discusses bonds and their valuation. There are several types of bonds including treasury bonds, corporate bonds, municipal bonds, and foreign bonds. Key characteristics of bonds include the par value, coupon interest rate, maturity date, call provisions, and sinking fund provisions. Bond prices are affected by interest rate changes which can create price risk and reinvestment risk for bondholders. The value of a bond is calculated based on the present value of its future cash flows, discounted at the current market rate of interest.
The document discusses bonds and their valuation. There are several types of bonds including treasury bonds, corporate bonds, municipal bonds, and foreign bonds. Key characteristics of bonds include the par value, coupon interest rate, maturity date, call provisions, and sinking fund provisions. Bond prices are affected by interest rate changes which can create price risk and reinvestment risk for bondholders. The value of a bond is calculated based on the present value of its future cash flows, discounted at the current market rate of interest.
The document discusses bonds and their valuation. There are several types of bonds including treasury bonds, corporate bonds, municipal bonds, and foreign bonds. Key characteristics of bonds include the par value, coupon interest rate, maturity date, call provisions, and sinking fund provisions. Bond prices are affected by interest rate changes which can create price risk and reinvestment risk for bondholders. The value of a bond is calculated based on the present value of its future cash flows, discounted at the current market rate of interest.
➢ a long-term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond ➢ issued by corporations and government agencies that are looking for long-term debt capital
▪ Treasury bonds
- also called government bonds
- no default risk - still exposed to risk of rising interest
▪ Corporate bonds
- issued by business firms
- exposed to default risk (credit risk)
▪ Municipal bonds
- also called munis
- issued by state and local governments - also exposed to default risk
▪ Foreign bonds
- issued by a foreign government or a foreign corporation
- exposed to default risk • Key Characteristics of Bonds
❖ Par Value
- face value - the amount of money the firm borrows and promises to repay on maturity date
❖ Coupon Interest Rate
- stated annual interest rate on a bond
o fixed-rate bond – interest rate is fixed for the entire life of the bond o floating-rate bond – a bond whose interest rate fluctuates with shifts in the general level of interest rate o zero coupon bond
– (zeros) a bond that pays no annual interest but is sold at a discount
below par, OID (original issue discount) bond
❖ Maturity Date
- specified date on which the par value must be paid
- original maturity, number of years to maturity at the time of issuance
❖ Call Provision
- gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date - call premium, additional sum paid on top of par value for calling the bonds - deferred call, bonds not callable on a specified number of years – call protection - refunding operation, company sells a new issue of low-yielding securities if and when interest rates drop, use the proceeds of the new issue to retire the high-rate issue, thus, reduce its interest expense
❖ Sinking Fund Provision
- a provision in a bond contract that requires the issuer to retire a portion of the bond issue each year - failure to meet sinking fund requirement constitutes a default - issuer can handle sinking fund requirement in two ways:
a. call in for redemption – when prevailing interest rate has fallen
b. purchase in open market – when prevailing interest rate has risen
• Other Features
❖ Convertible Bonds
- exchangeable for the issuing firm’s common stock at the option of the holder
❖ Warrant
- a long-term option to buy a stated number of shares of common stock at a specified
price
❖ Putable bond - allows investors to sell bonds back to the company prior to maturity at a prearranged price
❖ Income bond
- pays interest only if the issuer has earned enough money to pay the interest
❖ Indexed (Purchasing Power) Bond
has interest payments based on an inflation index so as to protect the holder from inflation
Bond Risks
• Price Risk
➢ the risk of a decline in a bond’s price due to an increase in interest rates
➢ higher for bonds with longer maturities ➢ relates to current market value of bond portfolio
• Reinvestment Risk
➢ the risk that a decline in interest rates will lead to a decline in income from a bond portfolio ➢ higher for bonds with shorter maturities ➢ relates to the income the bond portfolio produces
Investment Horizon – the period of time on investor plans to hold a particular investment
• Default Risk
➢ the risk that investors will receive less than the promised return
Bankruptcy and Reorganization
When a business becomes insolvent, a company can:
o Liquidate – sell its assets and pay its obligations
o Reorganization – negotiation between the creditors and the management ▪ Restructuring – reduce financial charges to level projected cash flows ✓ reducing interest rates of debt ✓ lengthening the term of maturity ✓ convert debt to equity – diluting position of common stockholders
BOND VALUATION
➢ based on the concept of time value of money, your peso tomorrow will be cheaper than your peso today
Par Value = 1,000,000
Coupon interest rate = 10%
(It is assumed that coupon interest rate = prevailing market interest rate at initial issuance.)
