1 / 46

Chapter 9

Chapter 9. Investing in Long-Term Debt (Bonds). Characteristics of All Bonds. Interest - coupon rate Principal amount Maturity date. Characteristics of All Bonds. The indenture The trustee Yield Current yield Yield to maturity. Risk to Bondholders.

ksamples
Download Presentation

Chapter 9

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 9 Investing in Long-Term Debt (Bonds)

  2. Characteristics of All Bonds • Interest - coupon rate • Principal amount • Maturity date

  3. Characteristics of All Bonds • The indenture • The trustee • Yield • Current yield • Yield to maturity

  4. Risk to Bondholders • Default - failure to meet the terms of the indenture • Fluctuations in interest rates • Reinvestment rate risk • Loss of purchasing power

  5. Importance of Ratings • Investment grade - triple B or better • Non-investment grade (high-yield bonds) • Moody’s and Standard & Poor’s ratings

  6. Importance of Ratings • Similarity of ratings • Ratings do change

  7. Types of Corporate Bonds • Mortgage bonds • Equipment trust certificates • Debentures • Subordinated debentures • Income and revenue bonds

  8. Types of Corporate Bonds • Convertible bonds • Variable interest rates bonds • Zero coupon and discount bonds • Eurobonds

  9. High-yield (Junk) Bonds • Non-investment grade • Poor quality increases the yields over investment grade bonds

  10. Bonds are Issued as • Bearer bond • Registered bond • Book-entry bond

  11. Price of a Bond • The present value of the cash flows • Interest and principal are discounted back to the present at the going rate of interest on comparable debt

  12. Comparable Debt • Same term to maturity • Same risk class

  13. Comparable Debt • Comparable bonds • can have different coupons • can have different prices

  14. Bond Pricing • Price (PV) of a $1,000 bond that pays 6% interest and matures after 3 years • Unknown: PV • PMT = 60 • FV = 1000 • N = 3 • I = 10 Answer: $1,000

  15. Same Bond at a Discount • Unknown: PV • PMT = 100 • FV = 1000 • N = 3 • I = 8 • The discount is the result of interest rates rising Answer: $948.62

  16. Same Bond at a Premium • Unknown: PV • PMT = 100 • FV = 1000 • N = 3 • I = 4 • The premium is the result of interest rates declining Answer: $1,055.56

  17. Relationship • The inverse relationship between • Bond prices and • Interest rates • Interest rate risk • Higher rates cause bond prices to decline

  18. Relationship Between Interest Rates and a Bond’s Price

  19. The Current Yield • Annual interest payment/Price of the bond • Current flow of interest as a % • $60/$948.62 = 6.3%

  20. The Yield to Maturity • The rate which equates • the present value of the cash inflows:the interest payment and principal repayment and • the cash outflow:the cost of the bond

  21. Yield to Maturity • Unknown: I • PV = $952 • PMT = $100 • FV = 1000 • N = 3 Answer: 12%

  22. Current Yield and Yield to Maturity • Current yield exceeds yield to maturity • if bond sells for a premium • Yield to maturity exceeds the current yield • if the bond sells for a discount

  23. Current Yield and Yield to Maturity • The current yield does not consider the premium or discount • The premium reduces the yield to maturity • The discount increases the yield to maturity

  24. Retiring Debt • Bonds issued in a series • Sinking funds • Call feature • Repurchases

  25. Features of Convertible Bonds • Convertible into common stock at the holder's option • Interest (coupon) • Maturity date • Call feature

  26. Convertible Bonds • The three possible outcomes • conversion • retirement at maturity • default

  27. Convertible Bonds • Number of shares into which the bond may be converted • Face value divided by the conversion price • $1000 / $20 = 50 shares

  28. Convertible Bonds • Conversion Price • Face value dividend by the number of shares into which the bond may be converted • $1000 / 50 shares = $20

  29. A Convertible Bond's Value as Stock • The number of shares times the price of the stock • 50 shares x $10 = $500

  30. Relationship • Between the price of a stock and the conversion value of the bond

  31. Value of a Convertible Bond as Debt • Model for the pricing of a bond applies • Present value of the • Interest payment • Principal repayment

  32. Value of a Convertible Bond as Debt

  33. Minimum Price • Minimum price of the bond combines • the value of the bond as stock and • the value as debt

  34. Minimum Price

  35. Actual Price of a Convertible Bond

  36. The Premiums • The premiums paid over • The bond's value as stock • The bond's value as debt

  37. The Premiums

  38. Importance of the Call Feature • Company may call the bond • Forced conversion • Price of stock exceeds conversion price

  39. Failure to Convert • Lose price appreciation • Receive face value

  40. Convertible Preferred Stock • The features associated with convertible bonds apply to convertible preferred stock • Except • the instrument is equity • lacks the safety associated with debt

  41. Federal Government Securities • Nonmarketble federal government debt • Series EE (“patriot”) bond

  42. Federal Government Securities • Marketable federal government debt • Treasury bills • Treasury notes and bonds • Zero coupon bonds

  43. Federal Debt • Amount of federal debt in existence primarily consists of • Treasury bills • Intermediate - term debt • Bonds • Emphasis on short-term debt

  44. Federal Debt and Risk • Safe from default • Risk from price fluctuations • Purchasing power risk

  45. Municipal Bonds (State and Local Government Debt) • The tax exemption • interest is exempt from federal income taxation • The taxable equivalent equation: ic (1 - t) = im

  46. Risks Associated with Municipal Bonds • Changes in interest rates • Purchasing power risk • Default

More Related