4-14-1

Business Finance(MGT 232)

Lecture 8

4-24-2

Bond ValuationBond ValuationBond ValuationBond Valuation

4-3

• Impact of Frequency in PV and PVA• Finding i and n in TMV problems• Amortizing a Loan• Loan Amortization Schedule

Overview of the Last Lecture

4-4

Bond ValuationBond Valuation

• What is a Bond?• Types of Bond• Characteristics of Bonds• Legal Aspects of Bonds• Bond Ratings• Bond Valuation• Yield on Bonds• Yield to maturity• Yield to Call

• Current Yield

• What is a Bond?• Types of Bond• Characteristics of Bonds• Legal Aspects of Bonds• Bond Ratings• Bond Valuation• Yield on Bonds• Yield to maturity• Yield to Call

• Current Yield

4-5

BondsBonds

A bondbond is a long-term debt instrument issued by a corporation or government.

A bond is a Long term contract under which borrowers agrees to make payments of interest and principal on specific dates to the bond holder.

A bondbond is a long-term debt instrument issued by a corporation or government.

A bond is a Long term contract under which borrowers agrees to make payments of interest and principal on specific dates to the bond holder.

4-6

Types of BondsTypes of Bonds

Treasury Bonds :

o Bonds issued by the government

o No default risk

Corporate Bonds:

o Bonds issued by the corporations

o Exposed to default risk

Municipal Bonds:

o Issued by state or local government

o It has default risk and low interest rate

Foreign Bonds:

o Default risk is involved

o Currency risk

Treasury Bonds :

o Bonds issued by the government

o No default risk

Corporate Bonds:

o Bonds issued by the corporations

o Exposed to default risk

Municipal Bonds:

o Issued by state or local government

o It has default risk and low interest rate

Foreign Bonds:

o Default risk is involved

o Currency risk

4-7

Characteristics of BondsCharacteristics of Bonds

• The discount ratediscount rate (required rate of return) is dependent on the risk of the bond and is composed of the risk-free rate plus a premium for risk.

• The discount ratediscount rate (required rate of return) is dependent on the risk of the bond and is composed of the risk-free rate plus a premium for risk.

The bond’s coupon ratecoupon rate is the stated rate of interest. The bond’s coupon ratecoupon rate is the stated rate of interest.

• The maturity valuematurity value (MVMV) [Par value or face value] of a bond is the stated value. It represents the amount of money the firm borrows or promises to repay on maturity date

• The maturity valuematurity value (MVMV) [Par value or face value] of a bond is the stated value. It represents the amount of money the firm borrows or promises to repay on maturity date

4-8

Characteristics of BondsCharacteristics of Bonds

• Maturity date - Bonds have specified maturity date on which the par value be repaid

• Provisions to Call (or redeem bonds) –

• Call Price

• Call premium

• Deferred call and Call protection

• Call redemtion

• Convertible Bonds

• Bonds with purchase warrants

• Income Bonds

• Maturity date - Bonds have specified maturity date on which the par value be repaid

• Provisions to Call (or redeem bonds) –

• Call Price

• Call premium

• Deferred call and Call protection

• Call redemtion

• Convertible Bonds

• Bonds with purchase warrants

• Income Bonds

4-9

Different Types of BondsDifferent Types of Bonds

A non-zero coupon-paying bondnon-zero coupon-paying bond is a coupon-paying bond with a finite life.

A zero-coupon bondzero-coupon bond is a bond that pays no interest but sells at a deep discount from its face value.

A non-zero coupon-paying bondnon-zero coupon-paying bond is a coupon-paying bond with a finite life.

A zero-coupon bondzero-coupon bond is a bond that pays no interest but sells at a deep discount from its face value.

4-10

Legal Aspects of Bonds

Indenture Trustee

4-11

Bond Ratings• Bonds are given ratings to reflect their

probability of going into default.RATING IMPORTANCE

AAA

AA

A

BBB

Investment grade bonds(high quality bonds, less risk)

BB

CCC

CC

C

Speculative bonds(high risk , low cost)

D In default

4-12

Bond Ratings

• Ratings effects the stability and cost

• International credit rating agencies:• Moody’s International• Standards and Poors Inc.

• CRA in Pakistan:• PACRA• JCR-VIS

4-13

Summary

• What is a Bond?• Types of Bond• Characteristics of Bonds• Legal Aspects of Bonds• Bond Ratings