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Types of Bonds
Debentures
Any unsecured long-term debt
Viewed as more risky than secured bonds and provide a
higher yield than secured bonds
Subordinated Debenture
Hierarchy of payout in case of bankruptcy
Mortgage Bond
A bond secured by a lien on real property
Euro Bonds
Securities (bonds) issued in a country different from the
one in whose currency the bond is denominated
Zero Coupon Bonds
Do not make regular interest payments
Issued at a significant discount
Return comes from appreciation of the bond.
Series EE government savings bondspurchase for $500,
payback is $1,000
Junk Bonds
High risk debt with low ratings by Moodys and Standard &
Poors
High yieldtypically pay Three to Five percent more than
AAA grade long-term bonds
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Current Yield
Current yield:
the ratio of the interest payment to the bonds current
market price.
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Definitions of Value
Book value:
value of an asset as shown on a firms balance sheet
Liquidation value:
the dollar amount that could be realized if an asset were
sold individually and not as part of a going concern.
Market value:
the observed value for the asset in the marketplace
Intrinsic or economic value:
also called fair valuethe present value of the assets
expected future cash flows
Efficient Market
The values of all securities at any instant fully reflect all
available public information, which results in the market value
and the intrinsic value being the same
Determinants of Value
The value of an asset is its intrinsic value or the present value of
its expected future cash flows, when these cash flows are
discounted back to the present using the investors required
rate of return
Determinants of Value are:
Amount and timing of expected cash flows
Riskiness of the cash flows
Investors required rate of return for the investment
Finance_KEOWN_CH7.wpd (P..... 5)
V=
V =
OR,
C1
(1+k )1
C2
(1+k )2
+ ........
Cn
(1+k )n
t =1
Ct
(1+ k )t
Bond Valuation
The value of a bond is a combination of:
The present value of the interest payments
Plus
The present value of the par or face value
Vb =
t =1
$ It
(1+k )
$M
(1+ k )n
Bond Valuation
1.
2.
The market value of a bond will be less than the par value if the
investors required rate of return is above the coupon interest
rate; the value will be above par value if the investors required
rate of return is below the coupon interest rate.
3.
Long-term bonds have greater interest rate risk than do shortterm bonds.
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Par Value
When the investors required rate of return is equal to the coupon
interest rate, the bond has a market value of par or face value
Discount
The market value of a bond will be below the par or face when the
investors required rate is greater than the coupon interest rate. The
bond will sell at a Discount or below face value.
Premium
The market value of a bond will be above the par or face value when
the investors required rate is lower than the coupon interest rate. The
bond will sell at a Premium or above face value.
EX1:
EX2:
PMT
80
FV
1000
Result: 1000
EX3:
PV
?
i
6
PV
?
PMT
80
FV
1000
Result: 1084.24
PV
?
PMT
80
FV
1000
Result: 924.18
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