Bond Valuation Concepts and Calculations

Questions and Answers

What is Par Value?

Bond contract

Rules for bondholders

Sum of money promised to pay at expiration (correct)

Interest rate of the bond

What is the Coupon Rate?

The interest rate of the bond.

Bondholders receive semiannual payments.

True

What is an Indenture?

The bond contract between the issuer and the bondholder. Signup and view all the answers

What are Covenants?

Rules outlined in the bond indenture. Signup and view all the answers

What are Affirmative Covenants?

Describes things the company pledges to do. Signup and view all the answers

What are Negative Covenants?

Describes things the company pledges not to do. Signup and view all the answers

What is the Cash Flow of a bond?

Final coupon payment + face value. Signup and view all the answers

What does PV represent in regards to a bond?

Current bond price. Signup and view all the answers

What does I/Y represent in regards to a bond?

Yield to Maturity (YTM). Signup and view all the answers

What is the Current Yield?

Annual Coupon/Market Price of the bond. Signup and view all the answers

What does PMT represent in regards to calculating a bond?

It represents the coupon payment. Signup and view all the answers

What is the expected price LLY Corporation should receive for each bond they issue?

$739.72 Signup and view all the answers

What is Ord's expected rate of return if bonds sell at $985?

6.35% Signup and view all the answers

What is the yield to maturity for XYZ's bonds selling for $975?

6.35% Signup and view all the answers

What are Debentures?

Unsecured bonds. Signup and view all the answers

What are Subordinated Debentures?

Bonds with a lower claim in liquidation. Signup and view all the answers

What are Mortgage Bonds?

Bonds backed by specific collateral. Signup and view all the answers

What are Zeros?

Zero coupon bonds. Signup and view all the answers

What are Junk Bonds?

Speculative bonds rated BB or below. Signup and view all the answers

What are Foreign Bonds?

Bonds issued by a foreign firm in the domestic currency. Signup and view all the answers

What are Convertible Bonds?

Bonds that can be converted into equity securities. Signup and view all the answers

Study Notes

Bond Valuation Concepts

Par Value: The face value of a bond; the amount repaid to the bondholder at maturity.
Coupon Rate: The interest rate on the bond; multiplied by par value gives the annual interest payment.
Semiannual Payments: Bondholders receive half of the annual coupon payment every 6 months.

Bond Indenture and Covenants

Indenture: The contract between bond issuer and bondholder; specifies bond features like coupon rate and maturity.
Covenants: Rules in the bond indenture that protect bondholders; include affirmative (obligations) and negative covenants (restrictions).

Cash Flow and Present Value

Cash Flow of a Bond: Total of the final coupon payment plus the face value.
PV (Present Value): Represents the current bond price; entered as a negative number in calculations.
I/Y (Yield to Maturity): Represents the market interest rate used to discount future cash flows.

Current Yield and Payment Calculation

Current Yield: Annual coupon payment divided by the market price of the bond; a rough estimate of yield to maturity.

Bond Pricing Examples

LLY Corporation Bond:
- Face Value: $1,000
- Coupon Rate: 7.25%
- Semiannual PMT: $36.25
- Market Return: 10% leads to PV of $739.72.
Ord's Bonds:
- Face Value: $1,000, Annual Interest: 6%
- Market Price: $985 leads to a return of 6.35%.
XYZ Corporation:
- Face Value: $1,000, Annual Interest: 6%
- Market Price: $975 leads to yield to maturity of 6.35%.

Types of Bonds

Debentures: Unsecured bonds without collateral; carry higher risk.
Subordinated Debentures: Unsecured bonds with lower claim on assets than regular debentures.
Mortgage Bonds: Backed by specific collateral, typically real estate.
Zeros (Zero Coupon Bonds): Bonds with no coupon payments; coupon rate is 0%.
Junk Bonds: Rated BB or below; considered speculative and high risk.
Foreign Bonds: Issued by foreign firms in a domestic market and currency.
Convertible Bonds: Bonds that can be converted into equity, usually common stock.

Duration Notion

Duration: A measure of the sensitivity of a bond’s price to changes in interest rates; provides insight into interest rate risk.

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Description

Test your understanding of bond valuation concepts, including par value, coupon rate, and cash flow calculations. This quiz covers key terms related to bond indentures, covenants, and present value analysis. Perfect for finance students looking to enhance their comprehension of bonds.