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# Corporate Bond

Status:
~ Bondholders are creditors (lenders)
~ They cannot vote suitable members in
boardrooms
~ Investment made is refunded once it is
called
back.

Return:
~ They receive fixed coupon payment

circulated in Capital

How should I
make decision?

## If you do not spend it, you can save it or

lend it to someone else for interest earned.

## If you use money now, you may lose the

interest could be earned for future
consumption

payments

## Future value = fixed coupon payment

+ principal
(Yr1 + 2)

(Yr2)

= Coupon (%) X
Principal + Principal

Yr0

Yr1

## Coupon (%) X Principal

Coupon (%) X Principal
+ Principal
?
?
Present value =

Future Value
(1 + Market Interest Rate) year

Yr2

C
C
C
F
n
1
2
P(1i)(1i).(1i)(1i)n
Coupon rate x Principal (Par Value)

Coupon

## Bond holders required rate of

return or
Market interest rate

## For public listed companies ~

It is Cost of debt the rate of return
necessary to compensate bondholders

For bondholders ~
It is minimum Required rate of return
Rate of return necessary to justify
undertaking an investment

,P(1.)1(.06)1\$1,0
\$
6
0
\$
1

## Suppose that Jane is about to buy

bond that will mature in 1 year

~ Principle is \$1,000
~ Coupon rate is 6% per year
~ If bank depository or market interest
rate is 6%, Jane will be willing to pay

,P(1.8)1(.08)1\$981.4
\$
6
0
\$
1

## Suppose Citibank deposit rate rises to 8%

from 6%. The price of IBM bond now
becomes:

## price below its par value. If not, She better

invests in banks deposit.
IBM should sell at discount! (lower than
par value)

Implication

## As bank interest rate rises, price of

existing bonds falls
Because investors will choose deposit in
commercial bank who offers higher return
if compared to bond issue.
Bank rate = 8%
Coupon rate = 6%

Which one
you want?

,P(1.4)1(.04)1\$1,09.23
\$
6
0
\$
1

## Suppose Citibanks depository rate falls to 4%

from 6%
The price of IBM corporate bond now becomes:

Implication

## As bank interest rate falls, price of

existing bonds rise
Because investors will not choose deposit
in commercial bank who offers lower
return if compared to bond issue.
Bank rate = 4%
Coupon rate = 6%

Which one
you want?

## General Motors bonds have 5 years to

maturity. Interest is paid annually, the
bonds have \$1,000 par value, and
coupon interest rate and bank depository
rate is 8% per annum now.
1) What is the market price of these
bond?
2) If Citibank offers10%, what is the fair
price of this bond?

## 1) Central Bank & Commercial

Bank
In US

In UK

2) Inflation
Will you invest in bank if you have
surplus of pocket
money instead of spending it?
Because bank gives u interest rate that
higher than inflation rate to compensate
Thus, bank deposit or coupon rate are
inclusive of inflation concern.

## Nominal Interest Rate

= Real Interest Rate +
Inflation Rate

## Nominal Interest Rate

= Real Interest Rate + Inflation Rate
Implication

## Nominal Interest Rate

= Real Interest Rate + Inflation Rate

## Suppose bond coupon rate is 5% and the

current expected inflation rate is 3%

## It describes investors reacts to nominal

changes even though no changes in real
interest rate.

Interest Rates
(percent
per year)
Nominal interest rate

15%

10
5

0
Real interest rate

1965

1970

Thank

You