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Cost of Money
Risk
Inflation
6% Treasury Bond
4%
2%
0%
10 20 30
Years to Maturity
Financial Management - Reza Masri 4
What is a bond?
ri = r* + IP + MRP + DRP + LP
The value of financial assets
0 1 2 n
r ...
Value CF1 CF2 CFn
1,372 rd = 7%.
1,211
rd = 10%.
1,000
837
775 rd = 13%.
Years
to Maturity
30 25 20 15 10 5 0
Bond values over time
INT INT M
VB ...
(1 rd )1
(1 rd ) N
(1 rd ) N
90 90 1,000
$887 ...
(1 rd )1
(1 rd )10
(1 rd )10
rd = 10.91%
What is the YTC on a 9-year, 10% annual
coupon, $1,000 par value, $1,100 call price
bond, selling for $1,495?
INT INT M
VB ...
(1 ytc )1
(1 ytc) N
(1 ytc ) N
100 100 1,100
$1,495 ...
(1 ytc)1
(1 ytc) 9
(1 ytc )9
ytc = 4.21%
Definitions
Change in price
Capital gains yield (CGY)
Beginning price
Expected Expected
Expected total return YTM
CY CGY
An example:
Current and capital gains yield
= 0.1015 = 10.15%
Calculating capital gains yield
YTM = Current yield + Capital gains yield
CGY = YTM CY
= 10.91% - 10.15%
= 0.76%
Interest
Low High
rate risk
Reinvestment
High Low
rate risk
26
Evaluating default risk:
Bond ratings
Investment Grade Junk Bonds
32
Bankruptcy
Bankruptcy alternatives::
Reorganization
Liquidation
Typically, a company wants Reorganization,
while creditors may prefer Liquidation.
Priority of claims in liquidation
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
Reorganization