FIN111 Lecture Notes - Lecture 7: Opportunity Cost, Credit Risk, 6 Years

251 views15 pages

amaranthyak49

31 May 2018

School

Department

Course

Professor

For unlimited access to Class Notes, a Class+ subscription is required.

Week 7 – Bond Valuation and the Structure of Interest Rates

Corporate Bonds

Market for Corporate Bonds

• June 2011 – value of bonds outstanding in Aus. was $447 billion → second largest

portion of the Australian capital market

• Largest investors in corporate bonds are superannuation fund, investment funds and

life insurance companies

• Trades in this market tend to be in very large blocks of securities

• Most secondary market corporate bond transactions take place through dealers in

the over-the-counter (OTC) market

- NOT trading in the stock exchange – using phones or online

• Despite the large overall trading volume, only a small number of existing total bonds

actually trade on single day

- Result: corporate bond market is thin compared to market for money market

securities or corporate shares

- Thin = not as liquid, not much trading, infrequent

• Corporate bonds less marketable than securities with higher daily trading volumes

- Moeet ist that geat opaed ith shaes, oeet is uite stale

• Prices in corporate bond market also tend to be more volatile than that of securities

sold in market with greater trading volumes

• Ifoatio ot efleted i pies as effiietl ad the aket ist as effiiet as

those for shares or money market instruments

Bond Price Information

• Corporate bond market not considered very transparent; it trades predominantly

OTC, difficult for investors to view prices, trading volume

- If you are buying shares you can see how many people are buying and selling

every second

- Hard to trace

• Also, many corporate bond transactions are negotiated between buyer and seller;

there is little centralized reporting of these deals

• Information on individual bonds not widely published

find more resources at oneclass.com

Unlock document

This preview shows pages 1-3 of the document.
Unlock all 15 pages and 3 million more documents.

Already have an account? Log in

Types of Corporate Bonds

• Corporate bonds are long-term IOUs that represent clais agaist a opas

assets

- i.e. I can claim the money used to purchase later on

• Debt instruments where the interest income paid to investors is fixed for the life of

the contract are called fixed-income securities

• Steady income because the amount you will receive is fixed

• Three types of corporate bonds are – coupon bonds, zero coupon bonds, and

convertible bonds

• NOTE: not equity

Coupon Bonds

• Called coupon bonds because the coupon is attached to the bond. In the past

(before electronics) all bonds came with a piece of paper and at the bottom it had a

coupon to present to the company to claim interest

• These bonds have coupon payments fixed for life of bond, and at maturity, principal

is paid and bonds are retired

• Coupon bonds have no special provisions; provisions they do have are conventional

and common to most bonds, e.g., a call provision

• Coupon payment are the interest payments made to the bondholder

• Payments usually made annually or semiannually

• Sometimes called vanilla bond → plain and simple

Zero Coupon Bonds

• Companies sometimes issue bonds with no coupon payments, only offering one

payment at maturity

• Interest is the difference between the price paid for the bond and the face amount

received at maturity

• Zero coupon bonds sell well below their face value (at deep discount) because they

offer no coupons

• Not frequently issued in Australia

Convertible Bonds

• Bonds that can be converted into ordinary shares at pre-determined ratio at

discretion of bondholder

• Coetile featue allos odholdes to shae opas good fotues if the

opas shares rise above certain level

• Coesio atio is set so opas shae pie ust appeiate 5%-20% before it

is profitable to convert bonds into equity:

- To secure this advantage, bondholders willing to pay a premium

find more resources at oneclass.com

Unlock document

This preview shows pages 1-3 of the document.
Unlock all 15 pages and 3 million more documents.

Already have an account? Log in

Bond Valuation

A Bond

• Is a contract between the issuer (borrower) and the investor (lender) stipulating the

issues oligatios to ake speified paets o speified futue dates

• Has a value equal to the present value of all cash flows associated with holding the

bond

• Cash flos osist of peiodi iteest paets ad the epaet of the fae

value upon maturity

• Yield to maturity → required rate of return, or discount rate for a bond is the market

interest rate

• To alulate ods pie, follo sae poess as to alue a fiaial asset:

1. Estimate expected future cash flows – coupons and the principal of the bond

2. Deteie ods euied ate of return, or discount rate

3. Calculate current value, or price of a bond (PB) by calculating the present value

of ods epeted ash flos

Bond Terminology

Principal

The amount of money on which interest is paid

Maturity date

The date he a ods life eds ad the ooe ust make the final interest

payment and repay the principal

Par Value

The face value of a bond, which the borrower repays at maturity

Coupon

A fixed amount of interest that a bond promises to pay investors

Coupon rate

The ate deied  diidig the ods annual coupon payment by its par value

Coupon yield

The aout otaied  diidig the ods oupo  its uet aket pie

(which does not always equal its par value). Also called current yield

Yield to Maturity

The market required rate of return for bonds of similar risk and maturity

find more resources at oneclass.com

Unlock document

This preview shows pages 1-3 of the document.
Unlock all 15 pages and 3 million more documents.

Already have an account? Log in

Document Summary

Week 7 bond valuation and the structure of interest rates. Not trading in the stock exchange using phones or online: despite the large overall trading volume, only a small number of existing total bonds actually trade on single day. Result: corporate bond market is thin compared to market for money market securities or corporate shares. Thin = not as liquid, not much trading, infrequent: corporate bonds less marketable than securities with higher daily trading volumes. Mo(cid:448)e(cid:373)e(cid:374)t is(cid:374)(cid:859)t that g(cid:396)eat (cid:272)o(cid:373)pa(cid:396)ed (cid:449)ith sha(cid:396)es, (cid:373)o(cid:448)e(cid:373)e(cid:374)t is (cid:395)uite sta(cid:271)le: prices in corporate bond market also tend to be more volatile than that of securities sold in market with greater trading volumes. I(cid:374)fo(cid:396)(cid:373)atio(cid:374) (cid:374)ot (cid:396)efle(cid:272)ted i(cid:374) p(cid:396)i(cid:272)es as effi(cid:272)ie(cid:374)tl(cid:455) a(cid:374)d the (cid:373)a(cid:396)ket is(cid:374)(cid:859)t as effi(cid:272)ie(cid:374)t as those for shares or money market instruments. Bond price information: corporate bond market not considered very transparent; it trades predominantly. Otc, difficult for investors to view prices, trading volume.

Related Questions

QUESTION 1 The largest investors in corporate bonds are life insurance companies and pension funds. True False 5 points QUESTION 2 Most secondary market transactions for corporate bonds take place through dealers in the over-the-counter (OTC) market. True False 5 points QUESTION 3 The value (or price) of a bond is the present value of its expected future cash flows. True False 5 points QUESTION 4 Bond prices decline when the interest rate decreases. True False 5 points QUESTION 5 The face or par value for bonds is the amount paid to bondholders at maturity and is usually equal to $1,000. True False 5 points QUESTION 6 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond. True False 5 points QUESTION 7 Zero coupon bonds have no coupon payments so they sell for more than their par value. True False 5 points QUESTION 8 Interest rate risk is the risk that bond prices will fluctuate when the interest rate changes. True False 5 points QUESTION 9 US Treasury securities are considered risky investments because the coupon payments are unpredictable. True False 5 points QUESTION 10 Bonds are very difficult to value because their future cash flows are very difficult to predict. True False 5 points QUESTION 11 If the bond's coupon rate is equal to the market rate then the bond will sell at a price equal to its face value greater than its face value less than its face value equal to its foreign currency value, e.g., its price in British pounds 5 points QUESTION 12 When calculating the price of a bond that pays a semiannual coupon one needs to use double the number of years until maturity for the number of payments use half the annual coupon payment use half the annual rate of return as the discount rate all of the above 5 points QUESTION 13 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments more than the price of the bond equal to zero equal to the price of the bond less than the price of the bond 5 points QUESTION 14 Which one of the following statements is true? All else equal long-term bonds have lower price volatility than short-term bonds. There is an inverse relation between bond prices and market interest rates. All else equal short-term bonds are more risky than long-term bonds. All else equal US government bonds are more risky than corporate bonds. 5 points QUESTION 15 An investor owns a 10-year US government bond with a 9 percent coupon rate. If the yield-to-maturity on the bond is 8 percent then this bond is selling for its par value. a discount. a premium. its face value. 5 points QUESTION 16 BA Corp is issuing a 10-year bond with a coupon rate of 8 percent and a par value of $1,000. The market interest rate on similar bonds is currently 6 percent. If the coupon payments are made annually, what is the value of this bond? 5 points QUESTION 17 Knight, Inc. has issued a 3-year bond with a $1,000 par value and an annual coupon rate of 6 percent. The current market rate of interest is 5 percent. What is the value of this bond if the coupon payments are made semiannually? 5 points QUESTION 18 Diane Carter is interested in buying a 5-year zero coupon bond with a face value of $5,000. If the market interest rate on these types of bonds is currently 9 percent, what is the current price of this bond? 5 points QUESTION 19 Rudy Sandberg wants to invest in 4-year bonds that are currently priced at $933.76. The bonds have a coupon rate of 6 percent and annual coupon payments. If the par value of the bonds is $1,000, what is the bond's yield-to-maturity? 5 points QUESTION 20 You own a 5-year bond with a face value of $1,000 and a coupon rate of 5 percent with annual payments. The bond is currently worth $810.46. If market interest rates remain unchanged, what will be the value of the bond next year when there are 4 years left until maturity?

FIN111 Lecture Notes - Lecture 7: Opportunity Cost, Credit Risk, 6 Years

Document Summary

Get access

Related Documents

FIN111 Lecture 9: Week 9 – Share Valuation

ACST101 Lecture Notes - Lecture 11: Open Outcry, Risk Compensation, Seasoned Equity Offering

ACST101 Lecture Notes - Lecture 6: Premium Bond, Cash Flow, Interest Rate Risk

Related Questions