Professional Documents
Culture Documents
• Convertible bonds
o May be exchanged for shares of the firm’s stock
o Sell for a higher price than a comparable non-
convertible bond
o Bondholders benefit if the market value of the
company’s stock gets high enough
Equation 8.1
C1 C2 Cn + Fn
PB = + +…+
(1+ i ) (1+ i )2 (1+ i )
n
Exhibit 8.1 The exhibit shows a time line for a three-year bond that pays an 8
percent coupon rate and has a face value of $1,000. How much should we pay for
such a bond if the market rate of interest is 10 percent? To solve this problem, we
discount the promised cash flows to the present and then add them up.
C1 C2 C3 F3
PB = + + +
(1+ i ) (1+ i )2 (1+ i )3 (1+ i )3
$80 $80 $80 $1,000
= + + +
(1.10 ) (1.10 ) (1.10 ) (1.10 )3
2 3
Fmn
PB = mn
i
1+
m
m
Quoted interest rate
EAY = 1+ −1
m
• The quoted interest rate is the simple annual yield which is the
yield per period multiplied by the number of compounding
periods; for bonds with semi-annual interest payments, simple
annual yield is two times the semi-annual yield
Note: Plots are for a 1-year bond and a 30-year bond with a 10 percent coupon rate and annual payment
Note: Calculations are based on a bond with a $1,000 face value and a 10-year maturity and assume annual
compounding.
• Default risk is the risk that a borrower may not make payments
as promised
o Lenders are paid a default risk premium for purchasing securities
with default risk
o The default risk premium (DRP) is the difference between the yield
on a security with default risk and the risk-free rate
• The yield on U.S. Treasury bills is a proxy for the risk-free rate
since U.S. T-bills are considered to be free of default risk
Exhibit 8.6 The shape, or slope, of the yield curve is not constant over time. The exhibit shows two
shapes: (1) the curves for December 2020 and January 2017 are upward sloping, which is the shape
most commonly observed, and (2) the curve for September 2019 is downward sloping for maturities
out to five years.