ABMF4024 BUSINESS FINANCETutorial 4 Answer November 1, 2010
What are the key features of a bond?1.
Par or face value
. We generally assume a $1,000 par value, but par can be anything, and often $5,000 or more is used. With registeredbonds, which are what are issued today, if you bought $50,000 worth,that amount would appear on the certificate.2.
. The dollar coupon is the ³rent´ on the money borrowed,which is generally the par value of the bond. The coupon rate is theannual interest payment divided by the par value, and it is generally setat the value of k on the day the bond is issued. To illustrate, therequired rate of return on one of southern bell¶s bonds was 11 percentwhen they were issued, so the coupon rate was set at 11 percent. If the company were to float a new issue today, the coupon rate would beset at the going rate today (September 1999), which would be around7.7 percent.3.
. This is the number of years until the bond matures and theissuer must repay the loan (return the par value). The southern bellbonds had a 30-year maturity when they were issued, but the maturitydeclines by 1 year each year after their issue.4.
. Most bonds (except U.S. Treasury bonds) can becalled and paid off ahead of schedule after some specified ³callprotection period.´ Generally, the call price is above the par value bysome ³call premium.´ We will see that companies tend to call bonds if interest rates decline after the bonds were issued, so they can refundthe bonds with lower interest bonds. This is just like homeownersrefinancing their mortgages if mortgage interest rates decline. The callpremium is like the prepayment penalty on a home mortgage. Thesouthern bell bond issue did not contain a call provision.5.
. The southern bell bonds were issued in 1977, wheninterest rates were higher than they are today.6. This southern bell bond has
. It started with 60,because it was a 30-year bond with semiannual payments. It now hasonly 16 coupons remaining, because the bond matures in 8 more years.7.
is inherent in all bonds except treasury bonds--will theissuer have the cash to make the promised payments? Bonds arerated from AAA to D, and the lower the rating the riskier the bond, thehigher its default risk premium, and, consequently, the higher itsrequired rate of return, r
. Southern bell is rated AAA.8.
, such as convertibility and zero coupons will bediscussed later.
A call provision is a provision in a bond contract that gives the issuingcorporation the right to redeem the bonds under specified terms prior to the