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Lecture Fundamentals of corporate finance - Chapter 7: Interest rates and bond valuation

The goal in this chapter is to introduce you to bonds. After studying this chapter you will be able to understand: Important bond features and types of bonds, cond values and yields and why they fluctuate, bond ratings and what they mean, the impact of inflation on interest rates, the term structure of interest rates and the determinants of bond yields. | T7.1 Chapter Outline Chapter 7 Interest Rates and Bond Valuation Chapter Organization 7.1 Bonds and Bond Valuation 7.2 More on Bond Features 7.3 Bond Ratings 7.4 Some Different Types of Bonds 7.5 Bond Markets 7.6 Inflation and Interest Rates 7.7 Determinants of Bond Yields 7.8 Summary and Conclusions CLICK MOUSE OR HIT SPACEBAR TO ADVANCE Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd. T7.2 Bond Features Bond - evidence of debt issued by a corporation or a governmental body. A bond represents a loan made by investors to the issuer. In return for his/her money, the investor receives a legaI claim on future cash flows of the borrower. The issuer promises to: Make regular coupon payments every period until the bond matures, and Pay the face/par/maturity value of the bond when it matures. Default - since the above mentioned promises are contractual obligations, an issuer who fails to keep them is subject to legal action on behalf of the lenders (bondholders). If a bond has five years to maturity, an $80 annual coupon, and a $1000 face value, its cash flows would look like this: Time 0 1 2 3 4 5 Coupons $80 $80 $80 $80 $80 Face Value $ 1000 Market Price $_ How much is this bond worth? It depends on the level of current market interest rates. If the going rate on bonds like this one is 10%, then this bond has a market value of $924.18. Why? Stay tuned! T7.2 Bond Features (concluded) T7.3 Bond Rates and Yields Consider again our example bond. It sells for $924.18, pays an annual coupon of $80, and it matures in 5 years. It has a face value of $1000. What are its coupon rate, current yield, and yield to maturity (YTM)? 1. The coupon rate (or just “coupon”) is the annual dollar coupon as a percentage of the face value: Coupon rate = $80 /$_ = _ % 2. The current yield is the annual coupon divided by the current market price of the bond: Current yield = $ _ /_ = 8.66% T7.3 Bond Rates and Yields Consider again our example bond. It sells for . | T7.1 Chapter Outline Chapter 7 Interest Rates and Bond Valuation Chapter Organization 7.1 Bonds and Bond Valuation 7.2 More on Bond Features 7.3 Bond Ratings 7.4 Some Different Types of Bonds 7.5 Bond Markets 7.6 Inflation and Interest Rates 7.7 Determinants of Bond Yields 7.8 Summary and Conclusions CLICK MOUSE OR HIT SPACEBAR TO ADVANCE Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd. T7.2 Bond Features Bond - evidence of debt issued by a corporation or a governmental body. A bond represents a loan made by investors to the issuer. In return for his/her money, the investor receives a legaI claim on future cash flows of the borrower. The issuer promises to: Make regular coupon payments every period until the bond matures, and Pay the face/par/maturity value of the bond when it matures. Default - since the above mentioned promises are contractual obligations, an issuer who fails to keep them is subject to legal action on behalf of the lenders (bondholders). If a bond has .