Chapter: 07

Bonds and Their Valuation

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 What is Bond

 Long term debt instrument.

 Issued by corporations and government
agencies.
 Where borrower (issuer) agrees to make
payments of interest and principal on
specific dates to the Bond Holder.

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 Bond

A 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.

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 Different Types of Bond

 Treasury Bonds.
 Corporate Bonds.
 Municipal Bonds.
 Foreign Bonds.

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 Different Types of Bond
Treasury Bonds:
Bond issued by the government,
sometimes referred to as government
bonds. No default risk.

Corporate Bonds:
Bonds issued by the corporations. Involve
default risk (credit risk).

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 Different Types of Bond
Municipal Bonds:
Bonds issued by local governments.

Foreign Bonds:
Bond issued by foreign government or by
foreign corporation.

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Key Characteristics of Bonds
Par Value:
The face value of a Bond.

Coupon Payment:
The specified number of dollars of interest
paid each year.

Coupon Interest Rate:

The stated annual interest rate.
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 Key Characteristics of Bonds
Fixed Rate Bond:
A bond whose interest rate is fixed for its entire
life.
Floating Rate Bond:
A bond whose interest rate fluctuates with shifts
in the general level of interest rate.
Zero Coupon Bond:
A bond that pays no annual interest but is sold at
a discount below par, thus compensating
investors in the form of capital appreciation.
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 Key Characteristics of Bonds
Maturity Date:
A specific date on which the par value of a
bond must be repaid.
Original Maturity:
The number of years to maturity at the time
a bond is issued.

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 Key Characteristics of Bonds
Call Provision:
A provision in a bond contract that gives the issuer
the right to redeem the bonds under specified terms
prior to the normal maturity date.
(call premium, call protection, refunding operation)

Sinking Fund Provision:

A provision in a bond contract that requires the
issuer to retire a portion of the issue each year.

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 Key Characteristics of Bonds
Convertible Bond:
A bond that is exchangeable at the option of
the holder for the issuing firm’s common
stock.

Warrant:
A long term option to buy a stated number of
shares of common stock at a specified price.

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 Key Characteristics of Bonds
Putable Bond:
A bond with a provision that allows its investors to sell it
back to the company prior to maturity at a prearranged
price.

Income Bond:
A bond that pays interest only if it is earned.

Indexed (purchasing Power) Bond:

A bond that has interest payments based on an inflation
index so as to protect the holder from inflation.
(Inflation Protected Securities, TIPS)
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 Bond Valuation
Allied Food’s 15 year bonds pay $50 of interest
each 6 months. Par value of this bond is $1000.
Coupon rate is 10% with semiannual payments.
Going (nominal) rate is 5%. What is the value of
this bond today? If this is selling at $1500 in
market, should you buy this bond?

(practice: YTM, YTC if bond is callable at 1.1 time

of its par value at the end of 10th year)
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Class Summary

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