Bond Valuation 2018
Bond Valuation 2018
Bond Valuation 2018
Gladman Moyana
Coupon rate- The annual coupon divided by nominal value of bond. The rate used to
determine the periodic coupon payments(annual or semi-annual payments)
Maturity date(term of loan agreement)- specified date at which principal amount is paid
Yield or Yield to maturity(YTM)- rate required on the market in the bond. This is the
normal discount rate the we calculated as IRR or I/Y
Professor Wiseman’s tutorial note: Remember that PV calculated using a market related
rate is market value or current value and that given market value of a bond, and cash
flows we can calculate YTM as the discount rate for discounting cash flows to PV
1500
1400
1300
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1100
1000
900
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700
600
0% 2% 4% 6% 8% 10% 12% 14%
7-11
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Bond Prices: Relationship Between Coupon
and Yield
If YTM = coupon rate, then par value = bond price
If YTM > coupon rate, then par value > bond price
– Why?
– Selling at a discount, called a discount bond
If YTM < coupon rate, then par value < bond price
– Why?
– Selling at a premium, called a premium bond
1
1 -
(1 r) t F
Bond Value C
(1 r)
t
r
Debt Equity
– Not an ownership – Ownership interest
interest – Ordinary shareholders
– Lenders do not have vote for the board of
directors and other
voting rights
issues
– Interest is considered – Dividends are not
a cost of doing considered a cost of
business and is tax doing business and
deductible are not tax deductible
– Lenders have legal – Dividends are not a
recourse if interest or liability of the firm and
principal payments shareholders have no
are missed legal recourse if
dividends are not paid
– Excess debt can lead
– An all equity firm can
to financial distress not go bankrupt??
and bankruptcy
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The Bond Trust Deed(Bond Indenture)
Contract between the company and the
bondholders and includes
– The basic terms of the bonds
– The total amount of bonds issued
– A description of property used as security, if applicable
– Sinking fund provisions
– Call provisions
– Details of protective covenants
The coupon rate depends on the risk characteristics of the bond when issued
Which bonds will have the higher coupon, all else equal?
– Secured debt versus a debenture
– Subordinated debenture versus senior debt
– A bond with a sinking fund versus one without
– A callable bond versus a non-callable bond(deferred call)
High Grade
– Moody’s Aaa and S&P AAA – capacity to pay is
extremely strong
– Moody’s Aa and S&P AA – capacity to pay is very
strong
Medium Grade
– Moody’s A and S&P A – capacity to pay is strong, but
more susceptible to changes in circumstances
– Moody’s Baa and S&P BBB – capacity to pay is
adequate, adverse conditions will have more impact
on the firm’s ability to pay
Municipal Securities
– Debt of local governments
– Varying degrees of default risk, rated similar to
corporate debt
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Zero-Coupon Bonds
Make no periodic interest payments (coupon rate = 0%)
The entire yield-to-maturity comes from the difference between the
purchase price and the par value
Cannot sell for more than par value
Sometimes called zeroes, or deep discount bonds
Treasury Bills and RSA bond strips are good examples of zeroes
– Professor Wiseman’s tutorial Note: This has a direct link with FCF
valuations where we will say operating cash flow grow at the
nominal rate. This is an adaptation of the Fisher identity above.
When do we use the approximation above(R = r + i)