Documente Academic
Documente Profesional
Documente Cultură
Bonds
Valuation
A systematic process through which the price at which a
security should sell is established - Intrinsic value
THE BASIS OF VALUE
Real assets (houses, cars) have value due to services they provide
Financial assets (paper) represent rights to future cash flows
Value today is PV
Return
What the investor
receives for making an
investment
1 year investments
return = $ received / $
invested
Debt investors receive
interest. Equity
investors get dividends
+ price change
Definition
The rate of return on an investment is the
interest rate that equates the present value of
its expected cash flows with its current price
Return is also known as
Yield, or
Interest
FV1
(1 + k)
Bonds
Bonds represent a debt relationship in which
an issuing company borrows and buyers lend.
A bond issue represents borrowing from many
lenders at one time under a single agreement
10
Coupon Rates
Coupon Rate the fixed rate of interest paid
by a bond
In the past, bonds had coupons attached,
today they are registered
Most bonds pay coupon interest semiannual
11
12
13
14
15
16
17
18
PB PMT[PVFA k, n ] + FV[PVFk, n ]
The payment is 8%
x $1,000, or $80
annually. However,
it is received in the
form of $40 every
six months.
n represents the
number of interestpaying periods until
maturity, or
10 years x 2 = 20.
20
21
22
23
24
27
Call Provisions
If interest rates fall, a firm may wish to retire old, high
interest bonds by refinancing with new, lower interest
debt
28
29
Call Provisions
Valuing the Sure-To-Be-Called Bond
Requires that two changes be made to bond
valuation formula
PB PMT[PVFA k, n ] + FV[PVFk, n ]
n now represents
the number of
periods until the
bond is likely to be
called.
30
Call Provisions
The new formula becomes
PB = PMT[PVFAk,m] + CP[PVFk,m]
Where
m = time to call
CP = call price = FV + Call Premium
31
35
36
Risky Issues
Sometimes bonds sell for a price far below
what valuation techniques suggest
Issuing company may be in financial trouble
Buying the bond is very risky
In theory riskier loans should be discounted at
higher rates leading to lower calculated prices
37
Convertible Bonds
Unsecured bonds exchangeable for a fixed
number of shares of stock at the bondholder's
discretion
Conversion ratio - the number of shares of stock
received for each bond
conversion ratio
38
39
par value
conversion price
$1,000
$25
40 shares
The proceeds from selling those shares at the current market price were
40 x $29 $ 1,160
In addition the bond paid interest during the year of
42
43
Convertible Bonds
Effect of Conversion on Financial Statements
and Cash Flow
An accounting entry removes the value of
convertible bonds from long-term debt placing it
into equity as if new shares were sold
No immediate cash flow impact, but ongoing cash
flow implications exist
Interest payments stop
But dividend payments may start
45
To Buyers
46
Forced Conversion
A firm may want bonds converted
As stock price rises convertible represents a lost
opportunity to sell new equity at a higher price
47
48
49
50
53
Kinds of Bonds
Secured bonds and mortgage bonds
Backed by specific assets - collateral
Debentures
Unsecured bonds - riskier
Subordinated debentures
Lower in payment priority than senior debt
Junk bonds
Risky companies - high interest rates
54
55
57
58
59
60
Misleading Results
Off balance sheet financing makes financial
statements misleading
Missed lease payments can cause failure just like
a missed interest payment on debt
Not showing leases on the balance sheet can
mislead investors into thinking a firm is stronger
than it is
61
62
64
65
Residual Values
Residual valuethe value of asset at the end
of the lease
Makes lease pricing and return calculations
more complex
Important negotiating points between lessee
and lessor
66
67
68
69
Leveraged Leases
The ability to depreciate assets reduces taxes
Government shares the cost of ownership
Unprofitable firms lose this benefit as they pay no tax
But can get some benefits with a Leveraged Lease
70
71