Finance Chapter 5
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Bonds: Current Yield
This is how much Cash flow you get now, out of your investment (%)
Bonds: Capital Gains Yield
Capital Gains are just how they sound: How much will I get (or lose) from selling this bond, due to its change in price?
Bonds: Expected Total Return
= Exp. Current Yield + Exp. Capital Gains Yield
What is a sinking fund?
A sinking fund is owned by a trustee, to whom the corporate borrower makes periodic payments. The sinking fund is there to pay back investors when a bond matures.
If the coupon rate is lower than market rate, is the bond a premium or discount?
Discount (because the amount we pay back investors is lower each period, we can only charge a discount)
If the coupon rate is higher than the market rate, is the bond discount or premium?
Premium (because we will be paying investors more than market rates)
A company needs to expense interest of a bond at the market rate:
When a bond is sold at a discount ($775), it is because the market rate, (13%) is higher than the coupon rate (10%). As my company pays out interest at the discount rate, we expense the interest at the higher market rate. The extra expense gradually increases the book value of the bond to par value.
When a bond is sold at a premium ($1372), it is because the market rate is lower than our interest rate - so we can charge a higher rate. As we pay out interest at the coupon rate, we expense less than we pay so the value of the bond decreases until it reaches par value.
What do you do with your financial calculator if you pay interest 2 times a year instead of one time per year?
Double "n" and divide "i" by 2
How do you value the Yield to Call?
- N = # of years until call date
- FV = call price
Market Interest Rate or Yield to Market Rate
real risk-free rate of interest (doesn't really exist)
It is the interest rate with in riskless security with no inflation.
It is the average rate of inflation over the life of a security.
"risk free" rate of interest, or the interest rate of a treasury bill.(rT-Bill)
Default Risk Premium
The risk that the borrower will not pay interest or principal. This increases as riskiness of issuers increases.
Liquidity Premium (Marketability Premium)
An addition to interest based on the inability to convert the security into cash.
Maturity Risk Premium
Compares the Interest Rate Risk and Reinvestment Rate Risk to calculate risk of bond at maturity
Interest Rate Risk
As the bond gets older, interest rates may increase, causing the coupon rate to decline in value.
Reinvestment Rate Risk
If a bond is allowed to mature, and the investor needs to reinvest the bond, the investor will be stuck with the new market rate of interest.
How is the quoted market rate of interest calculated?
rd = rRF + DRP + LP + MRP
Can you explain each part?
How is a T-Bond Calculated?
rt-bond = rRF + MRP
What would you like to do?
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