Fundamentals of Corporate Finance Third edition Chapter 4 Valuing Bonds Brealey Myers Marcus ndamentals of Corporate Finan Brealey Myers Marcus slides by Matthew will IrwinMcGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 4- 1 Irwin/McGraw-Hill Chapter 4 Fundamentals of Corporate Finance Third Edition Valuing Bonds Brealey Myers Marcus slides by Matthew Will Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc.,2001
4-2 Topics Covered S Bond characteristics reading the financial pages SBond prices and yields )Bond prices and interest rates → YTM VS. current yield 少 Rate of return iNterest rate risk 少 The Yield Curve Nominal and real rates of Interest → Default risk Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 4- 2 Irwin/McGraw-Hill Topics Covered Bond Characteristics ➔reading the financial pages Bond Prices and Yields ➔Bond prices and interest rates ➔YTM vs. current yield ➔Rate of Return ➔Interest Rate Risk ➔The Yield Curve ➔Nominal and Real Rates of Interest ➔Default Risk
Bonds Terminology O Bond- Security that obligates the issuer to make specified payments to the bondholder S Coupon- The interest payments made to the bondholder OFace Value(Par Value or Maturity Value)-Payment at the maturity of the bond COupon rate- Annual interest payment, as a percentage of face value Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 4- 3 Irwin/McGraw-Hill Bonds Terminology Bond - Security that obligates the issuer to make specified payments to the bondholder. Coupon - The interest payments made to the bondholder. Face Value (Par Value or Maturity Value) - Payment at the maturity of the bond. Coupon Rate - Annual interest payment, as a percentage of face value
4-4 Bonds WARNING The coupon rate IS NOT the discount rate used in the Present value calculations The coupon rate merely tells us what cash flow the bond will produce Since the coupon rate is listed as a %o, this misconception is quite common Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 4- 4 Irwin/McGraw-Hill Bonds WARNING The coupon rate IS NOT the discount rate used in the Present Value calculations. The coupon rate merely tells us what cash flow the bond will produce. Since the coupon rate is listed as a %, this misconception is quite common
4-5 Bond pricing The price of a bond is the present value of all cash flows generated by the bond (i.e coupons and face value) discounted at the required rate of return cpn con cpn+ par PV= +,, (1+r)(1+r)2 (1+r) Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 4- 5 Irwin/McGraw-Hill Bond Pricing The price of a bond is the Present Value of all cash flows generated by the bond (i.e. coupons and face value) discounted at the required rate of return. PV cpn r cpn r cpn par r t = + + + + + + ( ) ( ) + .... ( ) 1 1 (1 ) 1 2