CH 7_IR and Bonds valuation Flashcards
What type of loan is a bond
interest only loan- borrower pays interest every period, but NONE of the principial is repaid until the end of the loan
Coupons
the interest payments that are paid out regularly
Face value or Par value
the value paid out at the end of the loan
what is the par value usually
1000
what is a bond that sells for pay value called
par bond
What is the coupon rate
the annual coupon/face value
$1000 bond with interest pay of $50
what is the coupon
what is the par value
what is the coupon rate
50
1000
50/1000= 5%
Time to maturityq
of year until the face value is paid
what changes- bond coupon or interest rates over time?
interest rates are what changes over time
when interest rates rise, what ahppens to the pv of bond remaining cf
falls down and the bond is worth less
what happens to bond value when interest rates fall
bond is worth more!
how can you determine the value of a bond on a particular date?
- know the # of periods remaining until maturity
- face value
- coupon
- market interest rate for bonds with similar features
What is yield to maturity
itnerest rate required in the market on a bond
Is yield and yield to maturity the same thing?
what is the graphical relationship between price and yield to maturity? (price and market interest rate)
YES!
price goes up, ytm goes down
price goes down, ytm goes up
what is the logic behind calcuating the present value of a bond
it is basically an annuity and then a lump sum at the end
use the pv of annuity formulas to calculate the present value and then add the lump sum
when the bonds coupon rate is = going interest rates in the market, bond will sell for?
its face value
when the bonds coupon rate is < going interest rates in the market, bond will sell for?
a discount
when the bonds coupon rate is > going interest rates in the market, bond will sell for?
a premium
what deos it mean if a bond is selling for a discount
BASICALLY, the bond is worth less than other bonds issued on the market today
therefore it is sold at a lower price so investors are getting the same benefit that others get on similar bonds
investors who invest in bonds w lower coupon rates than interest rate in market are losing out on money they would have gotten if they bought a different investmetn, therefore this levels the plaing field
What does it mean when a bond sells at a premium?
investors pay extra to buy the bond because they will recieve more money over the duration of th ebond
formula to calculate the pv of a bond?
logic
formula
bond value= pv of coupons + pv of face amt
bond value- c * (1- 1/(1+r)^t )/r + F/(1+r)^t
what is interest rate risk
risk that arises for bond owners from changing interest rates (market yields)
what two factors affect the sensitivity of a bond on interest rate changes
- time to maturity (longer = more risks)
- coupon rate (lower= more risk)
longer bonds= more risk
!!! duh because there is more time for interest rates to fluctuate
How to find the yield to maturity (r)
**CHECK THIS!!!
use a financial calculator
N= # OF PERIODS
PV= -CURRENT PRICE OF BOND
FV= +1000 USUALLY
PMT= +COUPON RATE * FV
2 types of security a corproatiion can issue
equity secrurity
debt security
equity security
ownership interest in the firm
paying dividends to shareholders iS not a cost of doing business and is therefore NOT TAX DEDUCTIBLE
residual claim: you have only rights to whats left over after laibilties paid
bankruptcy beenfit= cant cause bankruptyc by issues equity
debt securityi
debt must be repaid
creditors dont have voting power
paying interest on debt is A COST OF DOING BUSINESS, AND IS TAX DEDUCTIBLE
UNPAID DEBT=LIABILITY, creidots can take legal action (Can cause liqudiation or reorg)
possibility of financial failure
why do corporations often create debt securities that is relaly equity?
cuz of tax benefits of debt and possibility of having no bankruptcy from equity
long term debt vs shrt term debt
1 yr +
vs
1 yr or less
synonyms ofo debt secrutities
notes, debenture, bond
2 types of long term debt
public issue and privately placed
the bond indenture
written aggreement b/w corp and creditor
has:
- basic terms of bonds
- amounts of the bonds issued
- description of property used as security
- repayment agreement
- call provision
- detail of protective covenant
terms of a bond
pricipal value
security on bond
- collateral: whats pledged to protect creditors
- mortgage securitues: secure loaonds on mortgage of propertty
- debenture: unsecured debt with og maturity >10 years
- Notes: unsecured debt with og maturity <10 years
debenture
unsecrued bond (no specfific pledge is made)
note meaning
if maturity of unsecured bond (the eebenture) is less than 10 years when it is orginally issued
seniority
sometimes some bonds are senior and some are junior
senior bonds are paid off frist if bankruptcy
SINKING FUNDS ARE AN EXAMPLE
repayment
bonds can be repaid at maturity or they may be repaid in part or in entirety priior to maturity
ex of early repayment: :sinking fund
what is a sinking fund
A sinking fund is an account managed by the bond trustee for the purpose of repaying the bonds. The
company makes annual payments to the trustee, who then uses the funds to retire a portion of the debt. The
trustee does this by either buying up some of the bonds in the market or calling in a fraction of the
outstanding bonds. We discuss this second option in the next section.
There are many different kinds of sinking fund arrangements. The fund may start immediately or be delayed
for ten years after the bond is issued. The provision may require the company to redeem all or only a
portion of the outstanding issue before maturity. From an investor’s viewpoint, a sinking fund reduces the
risk that the company will be unable to repay the principal at maturity, so it’s credit positive.
Some bonds simply have a defined amortization schedule of blended principal and interest payments directly
to the investor. The disadvantage of this “amortizing bond” structure is that it significantly complicates
secondary trading and, therefore, comes with a liquidity premium
call provision
some bonds lalow companies to repurchase or call part/all of the bond
call price - stated value= call premium
(Call premium gets smaller over time)
not as important in early years bc bonds arent called early, they get caleld in later years