Bonds and Their Valuation Key Features of Bonds Bond Valuation Measuring Yield Assessing Risk 7-1 Chapter 7 What is a bond? A long-term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the holders of the bond. 7-2 Bond Markets Primarily traded in the over-the-counter (OTC) market. Most bonds are owned by and traded among large financial institutions. The Wall Street Journal reports key developments in the Treasury, corporate, and municipal markets. Online edition lists trading each day for the most actively-traded investment-grade, high-yield, and convertible bonds. 7-3 Key Features of a Bond Par value: face amount of the bond, which is paid at maturity (assume $1,000). Coupon interest rate: stated interest rate (generally fixed) paid by the issuer. Multiply by par value to get dollar payment of interest. Maturity date: years until the bond must be repaid. Issue date: when the bond was issued. Yield to maturity: rate of return earned on a bond held until maturity (also called the “promised yield”). 7-4 Effect of a Call Provision Allows issuer to refund the bond issue if rates decline (helps the issuer, but hurts the investor). Borrowers are willing to pay more, and lenders require more, for callable bonds. Most bonds have a deferred call and a declining call premium. 7-5 The Value of Financial Assets 7-8 0 1 2 N r% CF1 CFN CF2 Value ... Other Types (Features) of Bonds Convertible bond: may be exchanged mon stock of the firm, at the holder’s option. Warrant: long-term option to buy a stated number of shares mon stock at a specified price. Putable bond: allows holder to sell the bond back to pany prior to maturity. e bond: pays interest only when interest is earned by the firm. Indexed bond: interest rate paid is based upon the rate of inflation. 7-9 What is the opportunity cost of debt capital? The discount rate (ri) is the opportunity cost of capital, and is the rate that c
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