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Words 1039

Pages 5

Future Value Definition: (quoted from Harvard Business School online course material)

The future value of any amount of money today is the amount that it would be worth if it were invested and grew at the specified compound interest rate over a given time period.

Formula: F=P*(1+r)^n

Present Value Definition:

(Quoted from Harvard Business School online course material)

The present value of an amount to be received at a specified future date is the investment that we would need to make today that, with the benefit of compound interest, would grow to the same amount as the future amount to be received at the future date.

(quoted from p. 449 on Financial and Managerial Accounting by WHBC 16th ed.)

The present value of a future cash receipt is the amount that a knowledgeable investor will pay today for the right to receive that future payment. The exact amount of the present value depends on (1) The amount of the future payment, (2) The length of time until the payment will be received, (3) The rate of return required by the investor.

The present value will always be less than the future amount, because money received today can be invested to earn interest and grow to a larger amount in the future.

Formula: P=F/(1+r)^n

Now that you understand how future and present values work, you are ready to value the zero coupon loan issued by Austral Electronics Company. In the exercise, Austral issued an 8-year $1,000,000 zero coupon. Under this, Austral will receive $466,507 at the loan inception, and pay the lender $1,000,00 in eight years’ time when the loan matures.

Although Austral will not make any interest…...

...Bond Yields Interest rates have a big part in determining the yield of a bond. If interest rates rise, the bond will be worth less and if they fall bonds will be worth more. The Yield to Maturity or YTM is the rate of return the lender or borrower will earn if the bond is not sold before its maturity. It can be also referred to as the bond`s yield. In order to be able to calculate the Yield to Maturity, some of the things you would need to know are the current price, the par value, the interest payments, and the maturity date for the bond. A coupon is the stated interest payment made on a bond. The market value will be less than par value if the required rate of return is above the coupon interest rate. Bond will be valued above pay value if the required rate of return is below the coupon interest rate. Also, the lower the coupon rate the greater the interest rate risk. Interest rate risk refers to the risk of fluctuating interest rates. In other words, bond values have an inverse relationship to interest rates. Long-term bonds will have a greater interest rate risk than short-term bonds. Interest rates have a greater impact on long-term bonds because it takes longer for them to mature. Typically, the more you can earn from a bond the more risk there is to it. However, the more risk there is to a bond the more likely either the borrower might default. Bonds have a rating system which gives them a rating based on the......

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...BOND VALUATION Bond Bond is a long term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond Key characteristics: VB = value of a bond/bond price M = par or maturity value of the bond; it is the stated face value of the bond and this is amount that must be paid off at maturity and it is often equal to $ 1.000 INT = coupon payment or dollars of interest paid each year; (Coupon rate x Par value) rk = coupon interest rate; (coupon payment / par value) rd = the bond's required rate of the return; that is the market rate of interest for that type of bond; it is also called the yield N = number of years before the bond matures; maturity date is a date on which the par value must be repaid m = number of discounting periods per year The value of any financial asset - a stock, a bond, a lease, or even a physical asset such as an apartment building is simply the present value of the cash flows the asset is expected to produce. Bond Valuation The cash flows from a specific bond depend on the contractual features meaning the type of the bond. The following general equation, written in several forms, can be used to find the value of any bond, VB. = (1 + ) + (1 + ) + ⋯+ ) (1 + + ) + (1 + ∙ ) = (1 + So, the cash flows consist of an annuity of N years plus a lump sum payment at the end of Year N. 1. Standard coupon-bearing bond Standard coupon-bearing bond =the cash flows consist of interest payment......

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...Bonds are appealing to investors because they provide a generous amount of current income and they can often generate large capital gains. These two sources of income together can lead to attractive and highly competitive investor returns. Bonds make an attractive investment outlet because of their versatility. They can provide a conservative investor with high current income or they can be used aggressively by investors who prefer capital gains. Given the wide and frequent swings in interest rates, investors can find a variety of investment opportunities. In addition to their versatility, certain types of bonds can be used to shelter income from taxes. While municipal bonds are perhaps the best known tax shelters, some Treasury and federal agency bonds also give investors some tax advantages. Bonds are exposed to the following five major types of risk: (1) Interest rate risk: This affects the market as a whole and therefore translates into market risk. When market interest rates rise, bond prices fall, and vice versa. (2) Purchasing power risk: This is the risk caused by inflation. When inflation heats up, bond yields lag behind inflation rates. A bond investor is locked into a fixed-coupon bond even though market yields are rising with inflation. (3) Business/financial risk: This refers to the risk that the issuer will default on interest and/or principal payments. Business risk is related to the quality and integrity of the issuer, whereas financial risk relates to the......

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... a) The promises of the bond issuer and the rights of the bondholders are set forth in great detail in a bond’s indenture. b) The term to maturity of a bond is the number of years the debt is outstanding or the number of years remaining prior to final principal payment. The maturity date of a bond refers to the date that the debt will cease to exist, at which time the issuer will redeem the bond by paying the outstanding balance. c) The par value of a bond is the amount that the issuer agrees to repay the bondholder at or by the maturity date. d) The coupon rate, also called the nominal rate, is the interest rate that the issuer agrees to pay to the bondholder each year. The annual amount of interest payment made to bondholders during the term of the bond is called the coupon. The coupon is determined by multiplying the coupon rate by the par value of the bond. e) There are certain bonds that do not make periodic coupon payments, such as zero coupon bonds, step up notes, deferred coupon bonds and floating rate bonds. 2) What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky? f) An issuer generally wants the right to retire a bond issue prior to the stated maturity date. The issuer recognizes that at some time in the future interest rates may fall sufficiently below the issue’s coupon rate so that redeeming the issue and replacing it with another lower coupon issue would be......

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...Bond Concepts: Bond Pricing It is important for prospective bond buyers to know how to determine the price of a bond because it will indicate the yield received should the bond be purchased. In this section, we will run through some bond price calculations for various types of bond instruments. Bonds can be priced at a premium, discount, or at par. If the bond's price is higher than its par value, it will sell at a premium because its interest rate is higher than current prevailing rates. If the bond's price is lower than its par value, the bond will sell at a discount because its interest rate is lower than current prevailing interest rates. When you calculate the price of a bond, you are calculating the maximum price you would want to pay for the bond, given the bond's coupon rate in comparison to the average rate most investors are currently receiving in the bond market. Required yield or required rate of return is the interest rate that a security needs to offer in order to encourage investors to purchase it. Usually the required yield on a bond is equal to or greater than the current prevailing interest rates. Fundamentally, however, the price of a bond is the sum of the present values of all expected couponpayments plus the present value of the par value at maturity. Calculating bond price is simple: all we are doing is discounting the known future cash flows. Remember that to calculate present value (PV) - which is based on the assumption that each payment is......

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...How to Use Coupons Julie Rogers 04/04/2012 How to Coupon 1) Coupon Language a. Explanation of terms 2) Where to Get Coupons b. Places to find coupons 3) Organizing Your Coupons c. Helpful suggestions 4) Stacking Coupons d. How to maximize your coupons 5) Go To The Store e. Time to see 6) The Checkout Lane f. The experience of couponing How to use coupons Couponing is the technique of pairing up coupons with sales so you can get the best price on products you need. There is a large range of couponers. Some do it sporadically and others are extreme couponers. To be a couponer yourself, you need to understand the basics of how to pair up store coupons and manufacturer coupon, if your store doubles coupons and how to hold on your coupons to use them at the best time. The coupon language is like a foreign language. Here is a list of abbreviations, terms and definitions to help better understand the language used in couponing. $$/$$ - This means $ off when you spend $ amount. $/# - This means that you get $ off for every # you buy. B1G1 = Buy One Get One Free Blinkie = A coupon that prints out at a machine in the store. They are located by the product associated with that particular coupon. BOGO = Buy One Get One Free CAT = Catalina. A coupon that prints out at the register that is either $$ off your next purchase or $$ off a certain product. Closeouts - These are typically greatly reduced...

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...Chapter 7(13E) Bonds and Their Valuation Answers to End-of-Chapter Questions 7-1 From the corporation’s viewpoint, one important factor in establishing a sinking fund is that its own bonds generally have a higher yield than do government bonds; hence, the company saves more interest by retiring its own bonds than it could earn by buying government bonds. This factor causes firms to favor the second procedure. Investors also would prefer the annual retirement procedure if they thought that interest rates were more likely to rise than to fall, but they would prefer the government bond purchase program if they thought rates were likely to fall. In addition, bondholders recognize that, under the government bond purchase scheme, each bondholder would be entitled to a given amount of cash from the liquidation of the sinking fund if the firm should go into default, whereas under the annual retirement plan, some of the holders would receive a cash benefit while others would benefit only indirectly from the fact that there would be fewer bonds outstanding. On balance, investors seem to have little reason for choosing one method over the other, while the annual retirement method is clearly more beneficial to the firm. The consequence has been a pronounced trend toward annual retirement and away from the accumulation scheme. 7-2 Yes, the statement is true. 7-3 False. Short-term bond prices are less sensitive than long-term bond prices to interest rate......

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...Bond Market INTRODUCTION Presently, as there is a robust growth of industrial activity in our economy, the need for investment has grown significantly and has resulted in a strong credit growth Some disintermediation is expected to take place as the most creditworthy borrower seeks the lowest borrowing costs. This development has re-emphasized the fact that bond financing has to supplement the traditional bank financing to take care of the growing credit needs of the economy. The Indian debt market, particularly the government securities market, has undergone a significant transformation since the introduction of reforms in the financial markets in 1991-92. The primary objective behind the reforms has been to moderate liquidity growth, contain inflationary pressure, and conduct public debt management in a cost-effective manner. Various reforms have also been undertaken in the corporate debt market. The corporate bond market is an important segment of the financial market in terms of funds raised well as potential for future growth. The Securities and Exchange Board of India (SEBI) was established in 1992, to regulate the primary issue in equity and de markets and to ensure sound trading practices in the secondary market throu stock exchanges. The bond market is an important source of funding for both t government and corporate sector. The bond market, also known as the debt, credit, or fixed income market, is a market where participants buy and sell debt......

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...CHAPTER 3 MEASURING YIELD CHAPTER SUMMARY In Chapter 2 we showed how to determine the price of a bond, and we described the relationship between price and yield. In this chapter we discuss various yield measures and their meaning for evaluating the relative attractiveness of a bond. We begin with an explanation of how to compute the yield on any investment. COMPUTING THE YIELD OR INTERNAL RATE OF RETURN ON ANY INVESTMENT The yield on any investment is the interest rate that will make the present value of the cash flows from the investment equal to the price (or cost) of the investment. Mathematically, the yield on any investment, y, is the interest rate that satisfies the equation. ------------------------------------------------- P = ------------------------------------------------- ------------------------------------------------- where CFt = cash flow in year t, P = price of the investment, N = number of years. The yield calculated from this relationship is also called the internal rate of return. ------------------------------------------------- ------------------------------------------------- Solving for the yield (y) requires a trial-and-error (iterative) procedure. The objective is to find the yield that will make the present value of the cash flows equal to the price. Keep in mind that the yield computed is the yield for the period. That is, if the cash flows are semiannual, the yield is a semiannual yield. If the cash flows are......

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...Financial Management Unit 4 Unit 4 4.1 Introduction 4.2 Valuation of Bonds Types of Bonds 4.2.1 Irredeemable or Perpetual Bonds Valuation Of Bonds And Shares 4.2.2 Redeemable or Bonds with Maturity Period 4.2.3 Zero Coupon Bond Bondyield Measures 4.2.1 Holding Period Rate of Return 4.2.2 Current Yield 4.2.3 Yield to Maturity (YTM) 4.2.4 Bond Value Theorems 4.3 Valuation of Shares 4.3.1 Valuation of Preference Shares 4.3.2 Valuation of Ordinary Shares 4.4 Summary Solved Problems Terminal Questions Answers to SAQs and TQs 4.1 Introduction Valuation is the process of linking risk with returns to determine the worth of an asset. Assets can be real or financial; securities are called financial assets, physical assets are real assets. The ultimate goal of any individual investor is maximization of profits. Investment management is a continuous process requiring constant monitoring. The value of an asset depends on the cash flow it is expected to provide over the holding period. The fact that as on date there is no method by which prices of shares and bonds can be accurately predicted should be kept in mind by an investor before he decides to take an investment decision. The present chapter will help us to know why some Sikkim Manipal University 50 Financial Management Unit 4 securities are priced higher than others. We can design ......

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...Valuing Bonds 1. "What does a call provision [call feature] allow [bond] issuers to do, and why would they do it" (Cornett, Adair, & Nofsinger, 2014)? “A call provision on a bond issue allows the issuer to pay off the bond debt early at a cost of the principal plus any call premium. Most of the time a bond issuer is called, it is because interest rates have substantially declined in the economy. The issuer calls the existing bonds and issues new bonds at the lower interest rate. This reduces the interest payments the issuer must pay each year” (Cornett, Adair, & Nofsinger, 2014). 2. "Provide the definitions of a discount bond and premium bond. Give examples" (Cornett, Adair, & Nofsinger, 2014, p. 178). “A discount bond is simply a bond that is selling below its par value. It would be quoted at a price that is less than 100 percent of par, like 99.05. A premium bond is a bond selling above its par value. Its price will be quoted as over 100 percent of par value, like 101.15. A bond becomes a discount bond when market interest rates rise above the bond’s coupon rate. A bond becomes a premium bond when market interest rates fall below the bond’s coupon rate” (Cornett, Adair, & Nofsinger, 2014, p. 178). 3. "Describe the differences in interest payments and bond prices between a 5 percent coupon bond and a zero coupon bond" (Cornett, Adair, & Nofsinger, 2014, p. 178). “The 5 percent coupon bond pays annual interest...

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...BONDS AND SINKING FUNDS Amortization of Bond Premiums and Discounts *APPENDIX: The origin and calculation of bond premiums and discounts were discussed in Section 15.2. We will now look at the premiums and discounts from an accountant’s perspective. The point of view and the schedules developed here provide the basis for the accounting treatment of bond premiums, discounts, and interest payments. Amortization of a Bond’s Premium Bonds are priced at a premium when the coupon rate exceeds the yield to maturity required in the bond market. Suppose that a bond paying a 10% coupon rate is purchased three years before maturity to yield 8% compounded semiannually. The purchase price that provides this yield to maturity is $1052.42. The accounting view is that a period’s earned interest is the amount that gives the required rate of return on the bond investment. The interest payment after the first six months that would, by itself, provide the required rate of return (8% compounded semiannually) on the amount invested is 0.08 ϫ $1052.42 ϭ $42.10 2 The earned interest during the first six months from an accounting point of view is $42.10. The actual first coupon payment of $50 pays $50 Ϫ $42.10 ϭ $7.90 more than is necessary to provide the required rate of return for the first six months.7 The $7.90 is regarded as a refund of a portion of the original premium, leaving a net investment (called the bond’s book value) of $1052.42 Ϫ $7.90 ϭ $1044.52 This......

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... a) Bond – is a long term contract under which the borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond. Treasury bonds – sometimes referred to as government bonds, are issued by the U.S. federal government. These bonds have not default risk. However, these bonds decline when interest rates rise, so they are not free of all risk Corporate bonds – issued by corporate; exposed to default risk – if the issuing company gets into trouble, it may be unable to make the promised interest and principal payments. Different corporate bonds have different levels of default risk, depending on the issuing company’s characteristics and the terms of the specific bond. Default risk often referred to as “credit risk” and the larger the default or credit risk, the higher the interest rate the issuer must pay. Municipal bond – or “munis “ are issued by state and local governments. Like corporate bonds, munis have default risk. Munis offer one major advantage over all the other bonds is exempt from federal taxes and also from state taxes if the holder is a resident of the issuing state. Munis bonds carry interest rates that are considerably lower than those on corporate bonds with the same default risk Foreign bond – are issued by foreign governments or foreign corporations. Foreign corporate bonds are of course exposed to default risk, and so are some foreign government bonds. An additional risk exists if the bonds are......

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...Bond Valuation: * How do we use NPV to value bonds? One simply computes the present value of the cash flows at the appropriate rate of return. This corresponds approximately to the full price of the bond (as opposed to the listed price). * E.g.: a one period, $1000 bond, 10% coupon is valued at: $1037 (1100/1.06) if the market rate of return is 6%. The bond sells at a premium. * $1000 if the market rate of return is 10%. The bond sells at par. * $982 if the market rate of return is 12%. The bond sells at a discount. Tentative Conclusions * The higher the appropriate interest rate, the lower the price of the bond. * If the yield matches the coupon , then the bond sells at par. * If the yield is higher than the coupon, the bond sells at a discount. * If the yield is lower than the coupon, the bond sells at a premium Example: * Consider now an infinite bond, paying a 10% coupon, i.e. $100 forever. * Then if the market return is 10% the bond sells at 100/0.1 =1000. * If the market return is 6% the bond sells at 100/0.06 = 1667 * If the market return is 12% the bond sells at 100/0.12 = 833 * A tentative conclusion: it seems that longer maturity bonds are affected more by interest rate swings. * We will modify this conclusion later. Valuing a Bond * If today is October 1, 2010, what is the value of the following bond? An IBM Bond pays $115 every September 30 for 5 years. In September 2015 it......

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...STEP 2: WE ARE SOLVING FOR I/Y P/Y =12 NOTE: since you are saving MONTHLY, you must set P/Y to 12 N = 15 X 12 = 180 PV = -100000 PMT = -500 FV = 1500000 SOLVE FOR I/Y = 16.20% 12. USING BOND SPREADSHEET (covered later in course). You want to buy an A rated bond that matures in 15 years. The coupon rate is 8%. The yield on A rated bonds in the same maturity range is 7.5%. What price would you pay for this bond? Corporate bonds mature at PAR. Par = $1000 • Corporate bonds pay interest coupons SEMIANNUALLY. P/Y = 2 • The stated interest rate on the bond is fixed for the life of the bond. This is called the “Coupon rate.” • All bonds are priced to the market yield on bonds of similar type, quality and maturity. This yield is always changing and bonds adjust to it by the price fluctuating. If yields in the market go UP, bond prices go DOWN. SET BGN SET P/Y = 2 N = 30 (Remember N = P/Y times the number of years) I/Y = 7.5 In a bond problem I/Y is the yield on other similar bonds. DO NOT use the coupon rate on the bond. FV = 1000 All bonds mature at par. Par = 1000 PMT = 40 Bonds pay interest semiannually. This bond has a coupon rate of 8%. Annual interest = 8% x $1000 = $80 Each coupon is therefore half the annual interest of $80 or $40 SOLVE FOR PV 1071.32 PROBLEM A loan of $50,000 is due 10 years from today. The borrower wants to make annual payments......

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