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AUBURN FINC 3610 - Chapter 6

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Chapter 7 Bond Valuation May 061Interest Rates andBond Valuation2BondsDebt InstrumentBondholders are lending the corporation money for some stated period of time.Liquid AssetCorporate Bonds can be traded in the secondary market.Price at which a given bond trades is determined by market conditions and terms of the bond.3Bond TerminologyPar ValueUsually $1,000 also called Face ValueCoupon Interest RateBorrowers (firms) typically make periodic interest payments to the bondholders.MaturityTime at which the original principal (Par Value) is repaid to the bondholder.IndentureDocument which details the legal obligation of the corporation to the bondholders.4Bond RatingsMoody’s and Standard & Poors regularly monitor corporate financial statements and assign a rating to the corporation’s debtsimilar to a personal credit reportAAA Top QualityAAABBBBBBCCCCC Low QualityC No interest being paidD Currently in DefaultInvestment GradeSpeculativeLower Ratings are somewhat more susceptible to adverse effects of changes in circumstances and economic conditions than debt in higher rated categories.+/- systemChapter 7 Bond Valuation May 065Bond RatingsBond Ratings can change due to many factors.Corporate Bond RatingsMcDonalds AAATT AA-Caterpillar Corp A+3 Com BBBDelta Air Lines BBB-AOL BB-Planet Hollywood CCC+TWA CCCGolden Books Family Entmt DS&P Research Insight6Bond QuotesCur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾ +¼IBM 63/8 11 6.6 228 965/8 -1/8 Kroger 9s10 8.8 74 1017/8 -¼Source: Wall Street JournalCompany Issuing the Bond7Bond QuotesSource: Wall Street JournalCoupon Interest RateDetermines the Investor’s Periodic Cash FlowCash Flow = Interest Payment = Coupon Rate x ParFor IBM: .06375 x 1000 = $63.75/YearCur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾ +¼IBM 63/8 11 6.6 228 965/8 -1/8 Kroger 9s10 8.8 74 1017/8 -¼8Bond QuotesSource: Wall Street JournalYear of MaturityDetermines the Time frame for the InvestmentIBM Bond:11 = year 2011, therefore in 2006 this is a 5 year investmentCur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾ +¼IBM 63/8 11 6.6 228 965/8 -1/8 Kroger 9s10 8.8 74 1017/8 -¼Chapter 7 Bond Valuation May 069Bond QuotesSource: Wall Street JournalCurrent Yield (%)Current Yield = Coupon RateMarket Price= .066 = 6.6%6.375 96.625=Cur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾ +¼IBM 63/8 11 6.6 228 965/8 -1/8 Kroger 9s10 8.8 74 1017/8 -¼10Bond QuotesSource: Wall Street JournalDaily Trading Volume (,000)Cur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾ +¼IBM 63/8 11 6.6 228 965/8 -1/8 Kroger 9s10 8.8 74 1017/8 -¼11Bond QuotesSource: Wall Street JournalDaily Closing Market Price as a % of ParIBM Bond$Price = 965/8 % x 1000 = $966.25= 965/8x 10 = $966.25 Cur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾ +¼IBM 63/8 11 6.6 228 965/8 -1/8 Kroger 9s10 8.8 74 1017/8 -¼12Bond QuotesSource: Wall Street JournalChange in from Previous Day’s CloseCur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾ +¼IBM 63/8 11 6.6 228 965/8 -1/8 Kroger 9s10 8.8 74 1017/8 -¼Chapter 7 Bond Valuation May 0613Valuation: An OverviewThe value of an asset is its intrinsic value or the present value of its expected future cash flows, where these cash flows are discounted back to the present using the investor’s required rate of return.Value is impacted byAsset characteristicsInvestor attributesThese two areas determine the investor’s required rate of return14Basic Factors Determining ValueAsset CharacteristicsInvestor AttributesAsset value = Present value of expected cash flows discountedusing investor’s required rateTiming of cash flowExpected level of cash flowRiskiness of cash flowInvestor’s assessment ofthe riskiness of the asset’scash flowsInvestor’s willingness to bear riskInvestor’s required rate of return15Bond Valuation Model3 Cash FlowsAmount that is paid to purchase the bond (PV)Periodic Interest Payments made to the bondholders (PMT)Repayment of Par value at end of Bond’s life (FV)Other TerminologyTime frame for cash flows (N) = Bond’s Maturity Interest Rate for Time Value is the rate at which future cash flows are being discounted to present. (I/YR)16Bond Valuation ModelIBM Bond Timeline:Source: Wall Street JournalInvestor that purchases bond today for $966.25 will receive 5 annual interest payments of $63.75 and a $1,000 payment in 5 years.Cur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾ +¼IBM 63/8 11 6.6 228 965/8 -1/8 Kroger 9s10 8.8 74 1017/8 -¼63.75 63.75 63.75 63.75 63.751000.000 1 2 3 4 52006 2007 2008 2009 2010 2011Chapter 7 Bond Valuation May 0617Bond Valuation ModelCompute Bond’s Intrinsic Value63.75 63.75 63.75 63.75 63.751000.00Compute the Intrinsic Value for the IBM Bond given that you require a 8% return on your investment.$59.03$54.66$50.61$46.86$43.39$935.12$1000 (1.08)5$680.580 1 2 3 4 52006 2007 2008 2009 2010 201118Bond Valuation ModelCompute Bond’s Intrinsic Value63.75 63.75 63.75 63.75 63.751000.00$63.75 Annuity for 5 years$1000 Lump Sum in 5 years254.54+680.58935.12-680.58NI/YR PV PMT FVxP/YRNOM%EFF%P/YR5 8 ? 1000-254.54NI/YRPVPMTFVxP/YRNOM%EFF%P/YR5 8 ? 63.750 1 2 3 4 52006 2007 2008 2009 2010 201119Bond Valuation ModelCompute Bond’s Intrinsic Value63.75 63.75 63.75 63.75 63.751000.00$63.75 Annuity for 5 years$1000 Lump Sum in 5 yearsCompute PV of annuity and PV of Lump Sum in ONE Step-935.12NI/YR PV PMT FVxP/YRNOM%EFF%P/YR5 8 ? 100063.750 1 2 3 4 52006 2007 2008 2009 2010 201120Bond Valuation ModelSource: Wall Street Journal45 45.001000.0045 45 45 45 45 45Rather than receiving 4 annual payments of $90, the bondholder will receive 4x2 = 8 semiannual payments of 90÷2=$45.Cur NetBonds Yld Vol Close ChgAMR6¼27 6.8 6 91¼ -1½ATT 8.35s28 8.1 110 102¾


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AUBURN FINC 3610 - Chapter 6

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