# -PV=FVN/(1+I)N & FVAdue=FVAord(1+I) -Perpetuity: PV = PMT/I=\$100/0.

1=\$1000 -NPV(10,0,{100,300,-50},{1,2,1}) or NPV(10,0,{100,300,300,-50}) 10%,CF0=0 -INOM – Quoted or Stated Rate, ignores compounding effect -Periodic IPER – Interest each period = INOM/M, M-number compounding periods per year. -Effective/equivalent annual rate (EAR=EFF)- annual rate actually earned, accounting for compounding. EFF% for 10% semiannual. EFF%=(1+INOM/M)M-1=(1+0.1/2)2-1=10.25% EFF%=(1+INOM/M)MxN-1 -FV of \$100 after 3 years, 10% semiannual compounding: FV3=PV(1+INOM/M)MxN=PV(1+EFF%)N =\$100(1+0.1/2)2x3=\$100(1.05)6=\$134.01 -FV of a 3-year \$100 annuity, quoted rate 10%, compound semiannual: Payment annually, but compound every 6months FV3=100(1.05)4+100(1.05)2+100 Or find EAR and treat as annuity EAR=(1+0.1/2)2-1=10.25% N=3,I=10.25,PV=0,PMT=100,FV331.8 If asking PV: switch FV=0, find PV -To compare investments, look at EAR/EFF% Chap6 - r = r* +IP +DRP + LP + MRP. r is norminal rate, required return on a debt security. R* is real riskfree. IP is inflation pre. DRP is default risk pre. LP is liquidity pre. MRP is maturity risk pre. - STTre=IP, LTTre=IP+MRP, STCor=IP+DRP+LP, LTCor=IP+MRP+DRP+LP - IPN=(INFL1+INFL2+…INFLN)/N - MRPt=0.1%(N-1) -The PEH contends that the shape of the yield curve depends on investor’s expectations about future interest rates. If interest rate are expected to increase, LT rates will be higher than ST rates, and vice-versa. Thus, the yield curve can slop up, down, or even bow. Assumptions of the PEH: Assumes that the maturity risk premium for Treasury securities is 0. Long term rates are an average of current and future short term rates. If PEH is correct, you can use the yield curve to “back out” expected future interest rates. - (1.062)2 = (1.06)(1+x) X=6.4004%. PEH says that 1year securities will yield 6.4004%, 1 year from now. - (1.065)5=(1.062)2(1+x) X=6.7005%. PEH says that 3 year securities will yield 6.7005%, 2 years from now. Chap7 -Effect of a Call Provision: Allows issuers to refund the bond issue if rates decline(help issuer, hurts 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. -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 investor if rates decline after issuance. - Call x% of the issue at par, for sinking fund purposes (likely to be used if rd is below the coupon rate and the bond sells at a premium). Buy bonds in the open market (likely to be used if rd is above the coupon rate and the bond sells at a discount).

- The opportunity cost of debt capital: The discount rate (ri) is the opportunity cost of capital, and is the rate that could be earned on alternative investments of equal risk. ri=r*+IP+MRP+DRP+LP -PB>ParPremium(rd<rc). PB<ParDiscounted(rd>rc) -At the maturity, value of any bond must equal its par value. -If rd remains constant: The value of a premium bond decreases over time till reached par, discount bond increases, par bond stays the same. -Current yield (CY)=Annual coupon payment/Current Price -Capital gains yields (CGY)=Change in price/Beginning Price -Expected total Return=YTM=(Expected CY)+(Expected CGY) -A 10-year, 10% semiannual coupon bond selling for \$1,135.90 can be called in 4 years for \$1,050, what is its YTC? The YTM can be determined 8%. Solving for YTC is like YTM except time to call is N, and FV is call premium. N=8, PV=-1135.9, PMT=50, FV=1050, I=3.568 -YTCNOM=rNOM=3.568%x2=7.137% is the rate that broker quotes. -YTCEFF=(1.03568)2-1=7.26%. -The firm replaces bonds paying \$100 with bonds paying only \$80. Investors should expect a call, and to earn the YTCNOM of 7.137%, rather than YTM of 8%. A call is more likely to occur if a bond sells at a premium (coupon>rd). So, YTC on premium, YTM on par and discount. -Interest rate risk is the concern that rising rd will cause the value of a bond to fall. -Reinvestment risk is the concern that rd will fall, and future CFs will have to be reinvested at lower rates, hence reducing income. -Default Risk: Mortgage, debentures, subordinated debentures, investment-grade, junk. Investment Grade Bonds (from Baa,BBB), Junk Bonds (Ba,BB..). Factors affecting Default risk: Financial performance (Debt ratio, TIE ratio, current ratio), Qualitative factors-Bond contract provisions (Secured vs. Unsecured Debt, Senior vs. subordinated debt, guarantee and sinking fund provisions, debt maturity). Other factors: Earning stability, regulatory environment, potential antitrust or product liability, pension liabilities, potential labor problems) Chap 8 r^=expected rate of return =r1P1+r2P2+…rNPN r^HT=(-27%)(0.1)+(-7%)(0.2)+(15%)(0.4)+(30%)(0.2)+(45%) (0.1)=12.4% High r^ appears to be best investment, but have to account for risk. -

-SD measures total, or stand alone risk. The larger SD, the lower the probability that actual returns will be closer to expected returns. Larger SD is associated with a wider probability distribution of returns. -Coefficient of Variation: A standardized measure of dispersion about the expected value, that shows the risk per unite of return. CV=Standard deviation/Expected return

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