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Corp. Fin. Summ. 6
Corp. Fin. Summ. 6
Firm borrow money by issuing or selling bonds. A bond is an interest-only loan. The
interests payments either annually or semi-annually are called coupons. The amount
that a firm repays at the end of the loan is called face value or par value, which is
usually $1,000 for corporate bonds. The number of years it takes to pay the face or par
There are two types of bonds: Pure Discount Bond and Level Coupon Bond
1. Pure Discount Bond is called zeroes, deep discount bonds or original issue
discount bonds (OIDs). It has no interest payment. In this case, the Bond price
(Bo) = the present value of face value or par value. Examples of this type of
bonds are treasury bills, treasury strips. With treasury strips, when a firm buys a
coupon-bearing treasury issue, the coupon payments are “stripped” away from
the principal amount and then the firm sells each component to investors
separately.
semi-annual coupon payments and principal. So, the Bond price (Bo) = present
So, Bo =
FV = $1,000
r = discount rate or interest rate or YTM (Yield To Maturity) if expressed as an
annual rate.
YTM is the expected return on a bond that makes a bond market price equal the
An example:
OR
Use the calculator: N = 20 x 2 = 40; I% = 10/2% = 5%; PMT = $70/2 = 35; FV = $1,000;
PV= ? = -742.61
One of the bond concepts is market interest rate and bond price. This concept
presents that when bond price is greater than a 1,000, coupon is greater than YTM, we
have a Premium bond. When bond price is less than a 1,000, coupon is less than
YTM, we have a Discount bond. When bond price is equal to 1,000, coupon is equal to
Another concept is Bond Interest Rate Risks which are the changes in bond prices as
a result of fluctuating interest rates. With everything else equal, the longer it takes for a
bond to reach maturity, the greater the interest rates risk and the lower the coupon rate,
The formula for the percent change is [Ending value – Beginning value] ⁒ Beginning
value.
For example, if a bond price changes from 1,000 to 685 = (685 -1,000)/ 1,000 = -315 /
1,000 = -31.5%.
• The procedure of issuing bonds is that the board of directors approve it, then
SEC reviews the registration statement. After it has been accepted, it is then
• A bond indenture is a written agreement between the issuer and a trust company
o An indenture includes:
3. Seniority: states who takes claim in the order of senior, junior, and
subordinated debenture
gains yield
• A firm should expect to earn YTC on premium bonds and YTM on par and
discount bonds.