0 Up votes0 Down votes

173 views52 pagesApr 04, 2014

© © All Rights Reserved

PPTX, PDF, TXT or read online from Scribd

© All Rights Reserved

173 views

© All Rights Reserved

- VRDO Primer
- Reference Pricing Service From Bondweb Malaysia
- Bonds CD Bank Deposits Build First Wealth Part 4
- Cheyette Market Implied Ratings
- Appendix 9A
- Modeling Aircraft Loan & Lease Portfolios
- New Microsoft Word Document
- Ch06 SeatworkA
- 08_LasherIM_Ch08 (1)
- Bonds Solution
- What is AAA Rating
- Chapter 7a- Bonds Valuation
- BMM Ch4 Valuing Bonds
- b821 Block4unit9 Credit Liquidity and Operational Risk
- Government Securities Regulations
- Bond Basics
- ANALYSIS OF INVESTMENT DECISIONS.doc
- 3Q2003uk
- Fxtm - Model Question Paper
- Bond Market Perspectives March 1 2016

You are on page 1of 52

Topics in Chapter

Value =

Market risk aversion

Cost of debt

Cost of equity

Firms business risk

3

Par value: Face amount; paid at maturity. Assume $1,000. Coupon interest rate: Stated interest rate. Multiply by par value to get dollars of interest. Generally fixed.

(More)

4

Maturity: Years until bond must be repaid. Declines. Issue date: Date when bond was issued. Default risk: Risk that issuer will not make interest or principal payments.

Call Provision

Issuer can refund if rates decline. That helps the issuer but hurts the investor. Therefore, borrowers are willing to pay more, and lenders require more, on callable bonds. Most bonds have a deferred call and a declining call premium.

6

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 investors if rates decline after issuance.

7

Call if rd is below the coupon rate and bond sells at a premium. Use open market purchase if rd is above coupon rate and bond sells at a discount.

0 10% V=? 100 100 1 2 10

...

100 + 1,000

VB =

$100 (1 + rd)

. . . + + 1

$100 (1 + rd)N

$1,000 (1 + rd)N

= $90.91 + = $1,000.

. . . + $38.55 + $385.54

9

The bond consists of a 10-year, 10% annuity of $100/year plus a $1,000 lump sum at t = 10:

INPUTS

10 N

10 I/YR

OUTPUT

PV -1,000

100 PMT

1000 FV

10

INPUTS OUTPUT

10 N

13 I/YR

PV -837.21

100 PMT

1000 FV

When rd rises, above the coupon rate, the bonds value falls below par, so it sells at a discount.

11

INPUTS 10 N 7 I/YR 100 PMT 1000 FV

OUTPUT

PV -1,210.71

If coupon rate > rd, price rises above par, and bond sells at a premium.

12

Suppose the bond was issued 20 years ago and now has 10 years to maturity. What would happen to its value over time if the required rate of return remained at 10%, or at 13%, or at 7%? See next slide.

13

1,372

rd = 7%.

1,211

1,000

rd = 10%.

837 775

30 25 20 15 10 5

rd = 13%.

14

At maturity, the value of any bond must equal its par value. The value of a premium bond would decrease to $1,000. The value of a discount bond would increase to $1,000. A par bond stays at $1,000 if rd remains constant.

15

YTM is the rate of return earned on a bond held to maturity. Also called promised yield. It assumes the bond will not default.

16

YTM on a 10-year, 9% annual coupon, $1,000 par value bond selling for $887

0 1 9 10 90 1,000

rd=?

...

90 90

887

17

Find rd

VB =

INT

INT

INPUTS OUTPUT

10 N

I/YR 10.91

-887 PV

90 PMT

1000 FV

18

If coupon rate < rd, bond sells at a discount. If coupon rate = rd, bond sells at its par value. If coupon rate > rd, bond sells at a premium. If rd rises, price falls. Price = par at maturity.

19

INPUTS 10 N OUTPUT -1134.2 90 PV PMT 1000 FV

I/YR 7.08

Sells at a premium. Because coupon = 9% > rd = 7.08%, bonds value > par.

20

Definitions

Current yield =

21

Current yield

22

Cap gains yield = YTM - Current yield = 10.91% - 10.15% = 0.76%. Could also find values in Years 1 and 2, get difference, and divide by value in Year 1. Same answer.

23

Semiannual Bonds

1. Multiply years by 2 to get periods = 2N. 2. Divide nominal rate by 2 to get periodic rate = rd/2. 3. Divide annual INT by 2 to get PMT = INT/2.

INPUTS

OUTPUT

24

2N N

rd/2

I/YR

OK PV

INT/2 PMT

OK FV

PV -834.72

100/2 50 PMT

1000 FV

25

PRICE YIELD

26

A 10-year, 10% semiannual coupon, $1,000 par value bond is selling for $1,135.90 with an 8% yield to maturity. It can be called after 5 years at $1,050.

27

INPUTS 10 N OUTPUT

1050 FV

28

If you bought bonds, would you be more likely to earn YTM or YTC?

Coupon rate = 10% vs. YTC = rd = 7.53%. Could raise money by selling new bonds which pay 7.53%. Could thus replace bonds which pay $100/year with bonds that pay only $75.30/year. Investors should expect a call, hence YTC = 7.5%, not YTM = 8%.

29

In general, if a bond sells at a premium, then coupon > rd, so a call is likely. So, expect to earn:

30

rd = r* + IP + DRP + LP + MRP.

Here:

rd r* IP DRP LP MRP = Required rate of return on a debt security. = = = = = Real risk-free rate. Inflation premium. Default risk premium. Liquidity premium. Maturity risk premium.

31

rRF = (1+r*)(1+IP)-1 = r*+ IP + (r*xIP) r*+ IP. (Because r*xIP is small) rRF = Rate on Treasury securities.

32

Estimating IP

Treasury Inflation-Protected Securities (TIPS) are indexed to inflation. The IP for a particular length maturity can be approximated as the difference between the yield on a non-indexed Treasury security of that maturity minus the yield on a TIPS of that maturity.

33

A bond spread is often calculated as the difference between a corporate bonds yield and a Treasury securitys yield of the same maturity. Therefore:

Bonds of large, strong companies often have very small LPs. Bonds of small companies often have LPs as high as 2%.

34

Bond Ratings

S&P and Fitch Moodys

% defaulting within: 1 yr. 0.0 0.0 0.1 5 yrs. 0.0 0.1 0.6

AAA AA A Aaa Aa A

BBB

Baa Ba B Caa

35

Junk bonds:

BB B CCC

Source: Fitch Ratings

Long-term Bonds 10-Year T-bond

AAA AA A BBB BB B CCC

Yield (%)

Spread (%)

36

Financial ratios

Debt ratio Coverage ratios, such as interest coverage ratio or EBITDA coverage ratio Profitability ratios Current ratios

(More)

37

(S&P)

38

Secured versus unsecured debt Senior versus subordinated debt Guarantee provisions Sinking fund provisions Debt maturity

(More)

39

Other factors

40

Interest rate (or price) risk for 1year and 10-year 10% bonds

Interest rate risk: Rising rd causes bonds price to fall. rd 1-year Change 10-year Change 5% $1,048 10% 15% 1,000 956 4.8% 4.4% $1,386 1,000 749 38.6% 25.1%

41

Value

1,500

10-year 1-year

1,000

500

0 0% 5% 10% 15%

rd

42

The risk that CFs will have to be reinvested in the future at lower rates, reducing income. Illustration: Suppose you just won $500,000 playing the lottery. Youll invest the money and live off the interest. You buy a 1-year bond with a YTM of 10%.

43

Year 1 income = $50,000. At year-end get back $500,000 to reinvest. If rates fall to 3%, income will drop from $50,000 to $15,000. Had you bought 30-year bonds, income would have remained constant.

44

Long-term bonds: High interest rate risk, low reinvestment rate risk. Short-term bonds: Low interest rate risk, high reinvestment rate risk. Nothing is riskless! Yields on longer term bonds usually are greater than on shorter term bonds, so the MRP is more affected by interest rate risk than by reinvestment rate risk.

45

Term structure of interest rates: the relationship between interest rates (or yields) and maturities. A graph of the term structure is called the yield curve.

46

14% 12%

Interest Rate

10% 8% 6% 4% 2% 0%

MRP IP r*

11

13

15

17

Years to Maturity

47

19

Bankruptcy

48

If company cant meet its obligations, it files under Chapter 11. That stops creditors from foreclosing, taking assets, and shutting down the business. Company has 120 days to file a reorganization plan.

49

Company must demonstrate in its reorganization plan that it is worth more alive than dead. Otherwise, judge will order liquidation under Chapter 7.

50

Past due property taxes Secured creditors from sales of secured assets. Trustees costs Expenses incurred after bankruptcy filing Wages and unpaid benefit contributions, subject to limits Unsecured customer deposits, subject to limits Taxes Unfunded pension liabilities Unsecured creditors Preferred stock Common stock

51

In a liquidation, unsecured creditors generally get zero. This makes them more willing to participate in reorganization even though their claims are greatly scaled back. Various groups of creditors vote on the reorganization plan. If both the majority of the creditors and the judge approve, company emerges from bankruptcy with lower debts, reduced interest charges, and a chance for success.

52

- VRDO PrimerUploaded bybvahey
- Reference Pricing Service From Bondweb MalaysiaUploaded byMeor Amri
- Bonds CD Bank Deposits Build First Wealth Part 4Uploaded byAnil Selarka
- Cheyette Market Implied RatingsUploaded byobrefo
- Appendix 9AUploaded byAndreea Ioana
- Modeling Aircraft Loan & Lease PortfoliosUploaded byaviationdude
- New Microsoft Word DocumentUploaded byDebdeep Kar
- Ch06 SeatworkAUploaded bycydlings
- 08_LasherIM_Ch08 (1)Uploaded byEd Donaldy
- Bonds SolutionUploaded byspectrum_48
- What is AAA RatingUploaded byKhushbu Saini
- Chapter 7a- Bonds ValuationUploaded byAian Cortez
- BMM Ch4 Valuing BondsUploaded byms.Ahmed
- b821 Block4unit9 Credit Liquidity and Operational RiskUploaded byRenata Andrici
- Government Securities RegulationsUploaded byHarpott Ghanta
- Bond BasicsUploaded byadibandaru
- ANALYSIS OF INVESTMENT DECISIONS.docUploaded bySagar Paul'g
- 3Q2003ukUploaded bydds70
- Fxtm - Model Question PaperUploaded byRajiv Warrier
- Bond Market Perspectives March 1 2016Uploaded bydpbasic
- Managerial Finance Second UnitUploaded byadeepcdma
- Ch. 5 -13ed Bonds - Master (1)Uploaded bySehar Adil
- Bond StrategiesUploaded byamitva2007
- BOND-VALUATION.pptxUploaded byyvonneberdos
- Market Update 30th March 2018Uploaded byAnonymous iFZbkNw
- Sample Terms and Conditions of the BondsUploaded byKaiser Jane Roeger
- Ch07DW.pptUploaded byPrasanna Iyer
- Investment Chapter 10 (Group 9) FIXUploaded byGloria Lisa Susilo
- FM - Classes - 5-10.pptUploaded byAsif Hussain
- GEN MATH.docxUploaded byEricavianca Cabueñas

- Solutions Chapter 15 Internationsl InvestmentsUploaded by'Osvaldo' Rio
- BRM CH 19Uploaded by'Osvaldo' Rio
- 20140430 Daily ResearchUploaded by'Osvaldo' Rio
- Step 3 - Checking the Competitive Advantage PotentialUploaded by'Osvaldo' Rio
- Ch 3 - Evaluating Company's External EnvironmentUploaded by'Osvaldo' Rio
- Chapter 5 Profit CentersUploaded by'Osvaldo' Rio
- Solutions Chapter 4 Parity ConditionsUploaded byKenny Zhou
- Ch07 ShowUploaded byBagus Zijlstra
- 1st Session - Business LawUploaded by'Osvaldo' Rio
- Quantitative Demand AnalysisUploaded by'Osvaldo' Rio
- Ch06 ShowUploaded bypakistan
- Chap 04 Lec PptUploaded byJanine Jasper
- Operation Management - Project ManagementUploaded by'Osvaldo' Rio
- 1st Session - Chapter 1 - Overview of Financial Management and the Financial EnvironmentUploaded by'Osvaldo' Rio
- Bankruptcy LawUploaded byAlan Budi
- 01 COMPANY LAW.pptUploaded bybajax_lawut9921
- ch09Uploaded by'Osvaldo' Rio

- Bloomberg Markets Magazine 2014-05.BakUploaded byFeynman2014
- TODAYS REPORTFinalUploaded byShashank Dhall
- Basel II GuidelineUploaded byFarzana Siddique Dipa
- AdvancedUploaded byElaine Yap
- Money Market InstrumentsUploaded byFarrukh Uddin
- Indonesian Islamic banks.pdfUploaded byruni
- Class Presentation - FinalUploaded byAlex Wu
- Mrunal Explained_ Niti Aayog, Planning Commission, FunctionsUploaded byHemanth K Gowda
- Asian University of Bangladesh Core CoursesUploaded byEeasy Mee
- Islamic Real Estate Investment Trust as an Investment Asset for Waqf Management in Indonesia: Regulatory Framework and Shariah-CompliancyUploaded byYoga Prakasa
- CoursesUploaded byFawaz Mushtaq
- The Fair Value Option ASC 825 (FAS159) Student Ver S10 (2)Uploaded byandri juniawan
- Crowdfunding in Mexico: The Power of Digital Technologies to Transform Innovation, Entrepreneurship and Economic InclusionUploaded byar1815
- Revenue Regulations No, 3-98Uploaded byGlyza Kaye Zorilla
- smch01Uploaded byFratFool
- FM Assignment 1Uploaded byPalaniappan Sellappan
- 132254_20060630Uploaded bykevindsiza
- AFIN250 Tutorial 1Uploaded byDean Pham
- DCFUploaded byChatinont Yam
- CFPB Closing DisclosureUploaded byRichard Vetstein
- Rcbc 112-6 Bank Reconciliation 2013 (Autosaved)Uploaded byRenniel Dimalanta
- Oracle FCCS Getting Started Guide IIUploaded byAmit Sharma
- 37910-85-80780-1-10-20180604Uploaded byIda Ayu Adiatmayani Peling
- Goat Fattening FarmUploaded byZohaib Pervaiz
- Front Office Management and BudgetingUploaded bydamianuskrowin
- Business Plans for TranslatorsUploaded byapi-3741779
- Business Tax in ArgentinaUploaded byHarry
- RFI 2019-02 Airport Hangar ReutilizationUploaded byBoulder City Review
- Chapter 31 - Gripping IFRS ICAP 2008 (Solution of graded questions)Uploaded byFalah Ud Din Sheryar
- m.com. Module5 Sem IIUploaded byMayur Kundar

## Much more than documents.

Discover everything Scribd has to offer, including books and audiobooks from major publishers.

Cancel anytime.