Scribd Logo
Upload

Welcome to Scribd!

  • 576 views

    The Valuation of Bonds PPT at Bec Doms Finance

    Uploaded by

    Babasab Patil (Karrisatte)
    Bonds provide debt financing for companies and their value is determined by the present value of their expected cash flows. A bond's price and yield are inversely related to market interest rates - as rates rise, price falls and yield rises. Callable bonds allow issuers to refinance debt by repaying bonds early if rates decline. Convertible bonds can be exchanged for shares of stock, providing upside potential for investors but dilution of earnings per share for issuers.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd

    The Valuation of Bonds PPT at Bec Doms Finance

    Uploaded by

    Babasab Patil (Karrisatte)
    576 views37 pages
    Bonds provide debt financing for companies and their value is determined by the present value of their expected cash flows. A bond's price and yield are inversely related to market interest rates - as rates rise, price falls and yield rises. Callable bonds allow issuers to refinance debt by repaying bonds early if rates decline. Convertible bonds can be exchanged for shares of stock, providing upside potential for investors but dilution of earnings per share for issuers.

    Original Description:

    The Valuation of Bonds Ppt @ Bec Doms Finance

    Original Title

    The Valuation of Bonds Ppt @ Bec Doms Finance

    Copyright

    © Attribution Non-Commercial (BY-NC)

    Available Formats

    PPT, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Bonds provide debt financing for companies and their value is determined by the present value of their expected cash flows. A bond's price and yield are inversely related to market interest rates - as rates rise, price falls and yield rises. Callable bonds allow issuers to refinance debt by repaying bonds early if rates decline. Convertible bonds can be exchanged for shares of stock, providing upside potential for investors but dilution of earnings per share for issuers.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    576 views37 pages

    The Valuation of Bonds PPT at Bec Doms Finance

    Uploaded by

    Babasab Patil (Karrisatte)
    Bonds provide debt financing for companies and their value is determined by the present value of their expected cash flows. A bond's price and yield are inversely related to market interest rates - as rates rise, price falls and yield rises. Callable bonds allow issuers to refinance debt by repaying bonds early if rates decline. Convertible bonds can be exchanged for shares of stock, providing upside potential for investors but dilution of earnings per share for issuers.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 37

    The Valuation and Characteristics of Bonds

    The Basis of Value


    A securitys value is equal to the present value of its expected cash flows.
     A security should sell in financial markets for a price close to that value
     Differences of opinion exist about a securitys price because of different assumptions about cash flows and interest rates for PV calculations

    The Basis for Value


    Investing Using a resource to benefit the future rather than for current satisfaction  Putting money to work to earn more money  Common types of investments
      Debtlending money Equitybuying ownership in a business

    Return What the investor receives for making an investment For a 1 year investment the rate of return = $ received / $ invested Debt investors receive interest

    The Basis for Value


     Rate of return is the interest rate that equates the present value of an investments expected future cash flows with its current price  Return is also known as
     Yield  Interest
     Debt investments only

    Bond Valuation
     Bonds represent a debt relationship in which the issuing company borrows and the buyers lend.
     A bond issue represents borrowing from many lenders at one time under a single agreement

    Bond Terminology and Practice


     A bonds term (or maturity) is the time from the present until the principal is returned
     Bonds mature on the last day of their term  A bonds term gets shorter as it ages

     A bonds face (or par) value represents the amount the firm intends to borrow (the principal) at the coupon rate of interest
     Bonds are non-amortized debt - the entire principal is repaid at maturity

    The Coupon Rate


     Coupon Rate the fixed rate of interest paid by a bond
     Doesnt change over the bonds life

     In the past, bonds had coupons attached, today they are registered  Most bonds pay coupon interest semiannual

    Bond ValuationBasic Ideas


    Adjusting to Interest Rate Changes
     Bonds are originally sold in the primary market and trade subsequently among investors in the secondary market.  Although bonds have fixed coupons, market interest rates constantly change.
     What happens to the price of a bond paying a fixed interest rate in the secondary market when interest rates change?

    Bond ValuationBasic Ideas


     Buy a 20 year, $1000 par bond with a 10% coupon rate for $1,000.
     It promises 20 years of coupon payments of $100 each, and a principal repayment of $1,000 after 20 years

    Needing cash, you sell it early.


      Assume interest rates have risen and the market rate of return is 11% Investors can now buy new bonds with an 11% coupon rate for $1,000 so they will not pay $1000 for your bond but they will buy it for less than $1,000

     

    Bond prices and interest rates move in directions Bonds adjust to changing yields by changing price
      Selling at a Premium bond price above face value Selling at a Discount bond price below face value

    opposite

    Determining the Price of a Bond

    Example

    Q:A bond has 10 years to maturity, a par value of $1,000, and a coupon rate of 10%. What cash flows are expected from the bond? A:
    0 1 5 10

    $100

    a year for 10 years

    $100 $1,000 $1,100

    10

    Determining the Price of a Bond

    The Bond Valuation Formula


     The price of a bond is the present value of a stream of interest payments plus the present value of the principal repayment PB ! PV(interest payments) + PV(principal repayment)


    Interest payments are annuities--can use the present value of an annuity formula: PMT[PVFA k,n ] Principal repayment is a lump sum in the future--can use the future value formula: FV[PVFk, n ]

    11

    Cash Flow Time Line for a Bond


    Figure 7.1

    This is an ordinary annuity.

    This is a single sum.


    12

    Determining the Price of a Bond

    Two Interest Rates and One More


     Coupon Rate
      Determines the size of the interest payments The discount rate that makes the present value of the payments equal to the price of the bond in the market
     AKA yield to maturity (YTM)

     kthe current market yield on comparable bonds

     Current yield annual interest payment divided by bonds current price

    13

    Solving Bond Problems with a Financial Calculator


      Financial calculators have five time value of money keys With a bond problem, all five keys are used
         nnumber of periods until maturity I/Ymarket interest rate PVprice of bond FVface value (par) of bond PMTcoupon interest payment per period
     With calculators that have a sign convention the PMT and FV must be of one sign while the PV will be the other sign

     

    The unknown is either interest rate or present value (Price) Sophisticated calculators have a bond mode allowing easy calculations dealing with accrued interest
    14

    Determining the Price of a Bond


    Example 7.1
    Q: The Emory Corporation issued an 8%, 25-year bond 15 years ago. At the time of issue it sold for its par (face) value of $1,000. Comparable bonds are yielding 10% today. What must Emorys bond sell for in todays market to yield 10% (YTM) to the buyer? Assume the bond pays interest semiannually. Also calculate the bonds current yield.

    Example

    15

    Bond Example Continued


    Example 7.1

    A: Substituting the correct values into the equation gives us:

    Example

    This can also be calculated via a financial calculator: N PV FV PMT I/Y


    16

    Maturity Risk Revisited


     Relates to term of the debt
     Longer term bond prices fluctuate more in response to changes in interest rates than shorter term bonds  AKA price risk and interest rate risk

    17

    Price Changes at Different Terms due to an Interest Rate Increase from 8% to 10%
    Table 7.1

    18

    Finding the Yield at a Given Price


     Calculate a bonds yield assuming it is selling at a given price  Trial and error guess a yield calculate price compare to price given

    19

    Finding the Yield at a Given Price


    Example 7.3

    Q: The Benson Steel Company issued a 30-year bond 14 years ago with a face value of $1,000 and a coupon rate of 8%. The bond is currently selling for $718. What is the yield to an investor who buys it today at that price? (Assume semiannual interest.)

    Example

    20

    Call Provisions
     If interest rates fall, a firm may wish to retire old, high interest bonds  Refinance with new lower interest debt  To ensure their ability to refinance bonds, corporations make bonds callable
     Call provision gives right to pay off the bond early

     Investors dont like calls lose high interest  So issuers and investors Compromise
     Call provisions usually have a call premium  Call protection means the bond wont be called for a certain number of years.
    21

    The Refunding Decision


    When current interest rates fall below the bonds coupon rate, a firm must decide whether to call in the issue
     Compare interest savings to the cost of making the call:
     Call premium extra payment to bond holders  Flotation costs incurred in issuing new bonds, includes brokerage fees, administrative expenses, printing, etc.
    22

    Dangerous Bonds with Surprising Calls


    Bonds can have obscure call features buried in their contract terms.
     Most common type a sinking fund provision requires an issuer call in and retire a fixed percentage of the issue each year
     Usually no call premium  Determined by lottery
    23

    to

    Convertible Bonds
     Unsecured bonds exchangeable for a fixed number of shares of stock at the bondholder's discretion
     Bondholders can participate in the stocks price appreciation

     

    Conversion ratio - the number of shares of stock received for each bond Conversion price - the implied stock price if bond is converted into a certain number of shares
     Usually set 15-30% above the stocks market value when the bond is issued

    Usually issued at lower coupon rates


    24

    Advantages of Convertible Bonds


    To Issuing Companies  Convertible features are sweeteners enabling a risky firm to pay a lower interest rate Viewed as a way to sell equity at a price above market Usually have few or no restrictions To Buyers Offer the chance to participate in stock price appreciation Offer a way to limit risk associated with a stock investment

     

    25

    Forced Conversion
     A firm may want bonds converted
     eliminates interest payments on bond  strengthens balance sheet  dont want conversion at very high stock prices

     Convertible bonds are always issued with call features which can be used to force conversion  Issuers generally call convertibles when stock prices rise to 10-15% above conversion prices

    26

    Effect on Earnings Per ShareDiluted EPS


     Upon conversion convertible bonds cause dilution in EPS
     EPS drops due to the increase in the number of shares of stock

     Thus outstanding convertibles represent a potential to dilution of EPS

    27

    Effect on Earnings Per ShareDiluted EPS


    Example 7.7

    Q: Montgomery Inc. is a small manufacturer of mens clothing with operations in Southern California. It issued 2,000 convertible bonds in 1999 at a coupon rate of 8% and a par value of $1,000. Each bond is convertible into Montgomerys common stock at $40 per share. Management expected the stock price to rise rapidly after the convertible was issued and lead to a quick conversion of the bond debt into equity. However, a recessionary climate has prevented that from happening, and the bonds are still outstanding. In 2003 Montgomery had net income of $3 million. One million shares of its stock were outstanding for the entire year, and its marginal tax rate is 40%. Calculate Montgomerys basic and diluted EPS. A: Basic EPS is the firms net income divided by the number of shares outstanding, or $3,000,000 1,000,000 = $3.00.
    28

    Example

    Effect on Earnings Per ShareDiluted EPS


    Example 7.7

    Diluted EPS assumes all convertible bonds are converted at the beginning of the year. Two adjustments need to be made:
     Add Example

    the number of newly converted shares to the denominator:


     Shares 

    exchanged: Bonds par Conversion price = $1,000 $25 = 40


     Since

    each bond can be converted into 40 shares of stock and there are 2,000 bonds, the newly converted shares totals 80,000, or 40 x 2,000, bringing the total number of shares outstanding to 1,080,000.

    29

    Institutional Characteristics of Bonds


    Registration, Transfer Agents, and Owners of Record  Classify bonds as either bearer or registered bonds.
      Bearer bonds interest payment is made to the bearer of the bond Registered bonds interest payment is made to the holder of record

    Owners of registered bonds are recorded with a transfer agent.


       Keeps track of bonds for issuing companies Sends payments to owners of record Transfers ownership when bond is sold to another investor

    30

    Kinds of Bonds
     Secured bonds and mortgage bonds
     Backed by the value of specific assets - collateral

     Debentures
     Unsecured bonds issued with interest rates higher

     Subordinated debentures
     Lower in priority than senior debt

     Junk bonds
     Issued by risky companies and pay high interest rates

    31

    Bond RatingsAssessing Default Risk


     Bonds are assigned quality ratings reflecting their probability of default.
     Higher ratings mean lower default probability

     Bond rating agencies (such as Moodys, S&P) evaluate bonds (and issuers), and assign a rating
     Examine the financial and market conditions of the issuer

    32

    Bond RatingsAssessing Default Risk


     Why Ratings Are Important
     Ratings are the primary measure of the default risk associated with bonds  The rating determines the rate at which the firm can borrow
      A lower quality rating implies a higher borrowing rate A differential exists between the rates required on high and low quality issues.

    33

    Moodys and S&P Bond Ratings


    Table 7.2

    34

    Bond IndenturesControlling Default Risk


     Bond indentures attempt to prevent firms from becoming riskier after bonds are purchased by including restrictive covenants:
     Preclude entering high risk businesses  Limit further borrowing  Require certain financial ratios

     Safety is also provided by sinking funds


     Provide money for repayment of bond principal

    35

    The Advantages of Leasing


    Appendix 7-A

     No money down
     Lenders generally require a down payment  lessors usually do not

     Restrictions
     Lenders require covenants/indentures, lessors have few, if any, restrictions

     Easier credit with manufacturers/lessors


     Equipment manufacturers may lease their own products and will sometimes lease to marginally creditworthy customers
    36

    The Advantages of Leasing


    Appendix 7-A

     Avoiding the risk obsolescence


     Short leases transfer this risk to lessors

     Tax deducting the cost of land


     If real estate is leased - the lease payment can be deducted as an expense  If land is owned - it is not depreciable

     Increasing liquiditythe sale and leaseback


     A firm may sell an asset to a financial institution and lease back the same asset frees up cash

     Tax advantages for marginally profitable companies


    37

    You might also like