Ch 7- Class Notes Flashcards
What is a Bond
An IOU for a company/govt
What is par value
the face value of the bond, or the amount that you pay for –
What is the coupon rate
What is the couponn payment
How much you get paid when its time to get paid
What is the maturity date
When the bond expires and you get og price back + the coupon payment for the period
What is the yield or yield to maturity
A lot of bonds payment goes back to paper! These bonds used to be paper and basically every coupon on the bond is fixed at the time of printing! So when it was itme to recivie your payment, you would rip it off and hand it in to the bank!
The bank would you give you your coupon payment in exchange for the thing
What is the bond value formula?
PV of coupons + PV of face
or
PV annuity + PV of lump sum payment
How to do bonds in the calculator?
PMT= positive
FV= the face value SHOULD BE POSITIVE
N= coupon count (how many coupons do you have, or how many times will you get paid)
I/Y= interest rate per period (YIELD TO MATURITY!! NOT COUPON RATE)
PV= -( coupon rate x par value)
NOTE: PMT and FV can have negative signs when PV has a positive sign but THESE MUST BOTH ALWAYS BE THE SAME SIGN!!!!!!
Bond values decrease as interest rates go up!
When interest rate is low, bond value is high
Some people buy bonds when they think interest rate is going to go up!
if they dont tell you the par valu`e?
then assume it is 1000
most of the bonds we get are end bonds, os never press the begin unless you are sure
At par the coupon rate = yield rate
!!!!!!!!!11
If you take the issuers perseppctive on a bond
you are going into debt and OWE interest payments
FV= -
PMT= -
PV= +
IF YTM= coupon rate then
par value ?? bond price
=
If YTM > coupon rate, then
par value ?? bond price
>
Because coupons are not enough, we need to discount the future valeu so the bond will sell below par
If YTM < coupon rate, then
par value ?? bond price
<
Basically, the coupons you are paying ur buyers the coupons you have look reallllllllllly good!! so the bond will sell above par
What does Yield to Maturity mean
This is describing the state of the world and the general market
Bond= value of coupon annuity + discounted future value
How often do bonds pay?
mostly semi-annually bc a full year is a long wait and monthly payments would have too much admin costs
What does 8% semiannual-pay bonds look like?
what is n?
4% is paid ever 6 mos
n= # of half years
What does interest rate risk come from
fluctuating interest rates
what 2 things determine how sensitive a bond will be to interest rate risk
What can we do to lower interest rate risk
- low/short times to maturity (buy bonds closer to maturity)
- only buy coupons with higher rates:
-higher coupons help lower risk
Slide 7-118 problem
n= 15
i/y= ?
pv= 928.09
fv= 1000
pmt=-10%*1000
If a bond is trading at < 100% of par,
the market interest rate is higher than the coupon rate of the bond
Why would some businesses want to pay more interest? doesnt this reduce earnings?
YES! think about it like this
EBIT
-Interest
EBT
-Tax
Net Income
If you pay more interest, money is going to bond holders
More interest= less tax
This lowers earnings but this means that all the money from interest and the money from net income goes to investors (bond ohlders and share holders)
What do common shareholders do?
vote for the board of directors
board of directors are managers
Why are dividends not tax deductible
because it is a CHOICE!!! companies are not required to pay divdends like tehy are requried to pay investors
Bonds dont have votes, bonds have //////
indenturesw
What does the bond indenture state
the basic terms of the bond
the total amount of bonds issued
a description of porety used as security if applicable
sinking fund provisions
missed some slides
7-177 pick up
What is a callable bond
can be bought back prior to maturity
7-189
7.7 (STARTING HERE) What interest rate should we want?
this is based on the term structure of interest rates
What is the term structure of interest rates?
relationship between time to maturity and yields, all else equal
What is an upward sloping yield curve
the more you’re willing to lock in your debt, the higher the interest rate you will get! if you are willing to put away your money for 5y you will get 4% yield as oppposed to 3 mos you will get 0.5% yield curve
Downward sloping yield curve
-why does this happen
If you put away your money for a short term, you will get higher yield return (3 mos= 4.5%, 5 yrs= 0.5%)
this happens because the govt believes that the market will get worse in the long term so they will be able to pay less for yields
What are downard sloping yield curves and upward slopin yield curves examples of
term structure of interest rates
What are risks on Government bonds?
-you’re not worried that govt wont pay, they def will, but there are 2 risks you’re worried about
-INFLATION RISK PREMIUM: if inflation increases ur money loses value
- INTEREST RATE RISK PREMIUM: if interest rate goes up then bond prices will fall
Both of these risks cause upward sloping/downward sloping term structure
what causes upward sloping term structure
when interest rate risk premium» inflation risk premium
What causes downard sloping term structure
when interest rate risk premium«_space;inflation risk premium
what deterimes what government of canada (the safest bonds) must pay?
a real return
compensation for int. rate risk
compensation for inflation risk
what determines what corporations issuing bonds must pay?
real return
comp for int rate risk
comp for inflation risk
defaultl risk premium (company might go bankrupt)
liquidity premium (ability to sell the bonds if and when we want to)
+ anything else that afffects the risk to the bondholder
What is the price of a bond
PV
What is the yield of a bond
I/Y
As interest rates go up then bond prices will fall
