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Lecture Managerial finance - Chapter 5 provides knowledge of bonds, bond valuation, and interest rates. After studying this chapter you will be able to understand: Key features of bonds, bond valuation, measuring yield, assessing risk. | Lecture Managerial finance - Chapter 5: Bonds, bond valuation, and interest rates Chapter 5 Bonds, Bond Valuation, and Interest Rates 1 Topics in Chapter Key features of bonds Bond valuation Measuring yield Assessing risk 2 Key Features of a Bond Par value: Face amount; paid at maturity. Assume $1,000. Coupon interest rate: Stated interest rate. Multiply by par value to get dollars of interest. Generally fixed. (More ) 3 Maturity: Years until bond must be repaid. Declines. Issue date: Date when bond was issued. Default risk: Risk that issuer will not make interest or principal payments. 4 Call Provision Issuer can refund if rates decline. That helps the issuer but hurts the investor. Therefore, borrowers are willing to pay more, and lenders require more, on callable bonds. Most bonds have a deferred call and a declining call premium. 5 What’s a sinking fund? Provision to pay off a loan over its life rather than all at maturity. Similar to amortization on a term loan. Reduces risk to investor, shortens average maturity. But not good for investors if rates decline after issuance. 6 Sinking funds are generally handled in 2 ways 1. Call x% at par per year for sinking fund purposes. 2. Buy bonds on open market. Company would call if rd is below the coupon rate and bond sells at a premium. Use open market purchase if rd is above coupon rate and bond sells at a discount. 7 Value of a 10year, 10% coupon bond if rd = 10% 0 1 2 10 10% . V=? 100 100 100 + 1,000 $100 $100 $1,000 VB 1 + . . . + 10 + 10 1 + rd 1+ r d 1+ r d = $90.91 + . . . + $38.55 + $385.54 = $1,000. 8 The bond consists of a 10year, 10% annuity of $100/year plus a $1,000 lump sum at t = 10: PV annuity = $ 614.46 PV maturity value = 385.54 Value of bond = $1,000.00 INPUTS 10 10 100 1000 N I/YR PV PMT FV OUTPUT -1,000
