Interest and Bond Valuation (Bafin - Chapter 4 Discussion) PDF

INTEREST AND BOND VALUATION - kung pano kabilis babalik ang pera na ininvest INTEREST RATES OVERVIEW – - tumataas interest rate pag, the longer the period, the longer the maturity of bonds...

INTEREST AND BOND VALUATION - kung pano kabilis babalik ang pera na ininvest INTEREST RATES OVERVIEW – - tumataas interest rate pag, the longer the period, the longer the maturity of bonds, the Interest Rate - represents the cost of money. It is longer the maturity of a loan, the greater interest the compensation that a supplier of funds expects sya. Why? Bc tumataas risk and a demander of funds must pay. - tumataas risk bc ex. may loan for 10yrs, 2M ito. - It is the cost of borrowing. Nangutang ka may Hindi sure na mababayad so possible magkakaron patong na interest especially sa bonds ng default then may risk na. The longer the Required return – min. return that an investor is bonds, the longer the risk. The longer the risk, expecting to receive for their investment. tinataasan nila interest para pag mabayad mas Malaki ang babalik. High risk, high return. Kaibahan: Interest rate is applied to debt instruments such as bank loans or bonds. The real rate of interest/ real interest rate - Debt instrument ito An interest rate that has been adjusted for inflation (NR – IR) Required Return- is applied to equity investments, such as common stock, that gives the investor an The rate that creates equilibrium between the ownership stake in the issuer. supply of savings and the demand for investment funds in a perfect world, without inflation, where - Equity investments naman ito suppliers and demanders of funds have no liquidity - May appreciation ito, it means appreciation preferences and there is no risk sa price ng common stock such as kapag nag invest sa stock kapag tumaas value ng stock Nominal or Actual Rate of Interest may capital gains – ito ang required return The rate that is advertised by banks, debt issuers, Some factors that affect the equilibrium interest and investment firms for loans and various rate: means factors para tumaas o bumaba ang investment. It is the stated interest rate paid or interest rate earned to the lender or by investor. (RIR + IR) 1.Inflation – inflation increase, interest increase The nominal rate of interest is the actual rate of interest charged by the supplier of funds and paid Paano tumataas ang ir kapag may inflation by the demander. - tumaas inflation, tumataas bilihin, value ng peso TERM STRUCTURE OF INTEREST RATES bumababa The term structure of interest rates is the - kapag bumaba value ng peso, ang bond value ay relationship between the maturity and rate of bumababa din return for bonds with similar level of risk. - pag bumaba bond value, tumataas interest A graph of the relationship of maturity and rate of 2.Risk – interest rate risk – bond and interest return for bonds is called the yield curve. inversely proportional YIELD CURVES - pag mababa value ng loan/ bumaba value ng bond, tumataas ang interest rate A) Normal Yield Curve- an upward-sloping yield curve indicates that long-term interest rates 3.Liquidity preference – the fact that people, for are generally higher than short-term interest rates example people who are making investments, -pataas prefer to have cash, or assets that can be quickly -The longer the maturity, mas mataas ang interest exchanged for cash - Long term bonds, higher rate interest. B) Inverted Yield Curve- A downward- segment. Market segmentation theory states that sloping yield curve that indicates that short-term long- and short-term interest rates are not related interest rates are generally higher than long-term to each other because they have different interest rates. investors. - pababa - Nag bbase ito kung ano yung sinesegment ng market kung anong market tayo kase may diff market. RISK PREMIUMS Investors generally demand higher rates of return on risky investments as compared to safe ones. Otherwise, there is little incentive for investors to bear the additional risk. - Pag mas risky ang investment, mas Malaki dat Theories of Term Structure ang interest rate 1. Expectations Theory- the theory that the Legends: yield curve reflects investor expectations about future interest rate; an expectation of rising r1 – nominal rate of interest interest rates results in an upward-sloping yield rr – real rate of interest curve, and an expectation of declining rates results in a downward-sloping yield curve. DIRECT IP – Inflation Premium PROPORTIONAL RELATIONSHIP. RP1 – risk premium It suggests that an investor earns the same amount RF – risk free rate (RF = rr+ IP) of interest by investing in 2 consecutive one-yr bond investments vs investing in 1 two-yr bond Formula: today. Pag given risk free rate ito gagamitin - Direct proportional sila. Means, ang interest r1 = RF + RP1 rate pag tumataas, ang yield curve tataas din, vice versa. Pag may IP 2. Liquidity preference theory- the theory or r1 = rr+ IP + RP1 suggesting that long-term rates are generally higher than short-term rates (hence, the yield curve is upward sloping) because investors BONDS / bond valuation perceive short-term investments to be more liquid Characteristics: and less risky than long- term investments. Borrowers must offer higher rates on long-term 1. PAR – Face Value bonds to entice investors away from their - Always at PAR preferred short-term securities. - Face Value means kung ano ung stated value - Short term investment ay less risky. High ex. 2k ung shares mo then P2 per share, 2K term, high risk. ung FV. 2. COUPON RATE – rate of interest of 3. Market segmentation theory- the theory bonds, suggesting that the market for loans is segmented - Interest ng bonds natin on the basis of maturity and that the supply of and May 2 Interest: demand for loans within each segment determine NOMINAL – interest you will earned over the years its prevailing interest rate; the slope of the yield of the bond. (not compounded) curve is determined by the general relationship - Stated rate between the prevailing rates in each market EFFECTIVE – interest you will earned compounded 3. Stock purchase warrants- Instruments every year. that give their holders the right to purchase a If premium or at discount: certain number of shares of the issuer’s common If Nominal > Effective = Premium stock at a specified price over a certain period of - This is the normal when it comes to bonds time. kase pag nangutang ka, mayron itong interest It also offer investors the chance for capital gains, na kaakibat if the price of stock increases. If Nominal < Effective = at discount - Like conversion bond, the holder has the - Ito yung zero coupon bond or discount bond right, right to purchase a certain no. of - Pag inissue 1K par value, bibilhin lang ng 900 shares. pesos may disc. Pag babayad 1k pa rin - Diff nya sa CB, sa CB ang ibabayad ay common ibibigay. stock while sa SPW u only have the right to 3. MATURITY DATE – maturity of the bond purchase a certain no. of shares at a specified issued by company, price. but some company will pay the total amount of 4. Purchasing power bond – Bond that has bond before its maturity date. It is called Call interest payments based on an inflation index so as provision or call option. to protect the holder from inflation. - Kung kailan mag mamature ang bonds - Pag tumataas inflation, tumataas din ang interest dahil bumababa value ng pera, dito Other Features of BONDS parang pinoprotektahan ang holder na 1. Sinking fund provision it is a provision bumaba ang value ng bond nya. Kaya itong that requires a bond contract to retire a portion of PPB nagbbased sya sa inflation index ng the bond issue each year. It allows businesses that bond. have floated debt in the form of bonds to slowly save money and prevent a large lump-sum 5. Call feature- A feature included in nearly payment at maturity. all corporate bond issues that gives the issuer the - Parang nagiging installment ang bond opportunity to repurchase bonds at a stated call - Imbis na babayaran lump sum, mayron kang price prior to maturity portion na nareretire ung bond, each yr. a) Call Price- the stated price at which a bond 2. Conversion Features (CONVERTIBLE may be repurchased prior to maturity. BONDS) – Bonds that are exchangeable at the - irerepurchased ang bond meaning merong option of the holder for the issuing firms’ common stated na price na bago b4 maturity binibili stocks. Convertible bonds offer investors the chance for capital gains, if the price of stock b) Call Premium- the amount by which a bond’s increases. call price exceeds its par value - Ung bonds parang convertible bond, pag binili - always above the par meaning pag binayad yun or bumili ka ng bond dito may option ka ung or nirepurchased yon b4 maturity date mas holder naten for ex tayo bumili may option mataas dun sa par value nya. tayo na ibayad saken is issuing frinch common Legal Aspects of Corporate bonds stock, imbis na pera ibabayad, stock ang ibabayad, option ito ni holder. Sa corp bonds, ito ung pag nag issue ang private - Kapag may stock ako, may chance ako for comp ng bonds may bibili at bibili nito capital gains Bond Indenture- is a legal document that specifies - Capital gains kapag nag increase ung price ng both the rights of the bondholders and the duties stock ng isang company for ex binili ko 20 per of the issuing corporation. Included in the stock naging 25. Yung 5 pesos na inc ang indenture are descriptions of the amount and capital gains ,each stock. timing of all interest and principal payments, various standard and restrictive provisions, and, frequently, sinking-fund requirements and security 3) Imposed fixed-asset restrictions. The interest provision. borrower must maintain a specified level of fixed assets to guarantee its ability to repay the bonds. - (legal doc) It is protected by the law Asset for restrictions or fund for restriction – may Requirements that borrower must have to get extrang cash ang company ex meron kang 100k Bond Indenture: cash on hand, minsan ginagawa ng comp since excess mga to nag allot sila ng asset for restriction 1) maintain satisfactory accounting records – ito ung mag allot sila ng 50k ipambibili ng asset in accordance to GAAP itong fund hindi ginagastos, nakatabi pambili ng 2) periodically supply audited financial asset. statements - madalas tignan is BS at Income Statement 4) Constrain subsequent borrowing. 3) pay taxes and other liabilities when due Additional long-term debt may be prohibited, or 4) maintain all facilities in good working additional borrowing may be subordinated to the order. original loan. Components of Bonds Indenture Pag may utang si borrower na isa, additional long- term debt is minimized. Short term oki lang. pag 1. Standard Provisions- specifying certain pinautang ka pa nya, magdududa si holder ng recordkeeping and general business practices that bond if may pampabayad kapa don. Nag utang ka the bond issuer must follow; normally, they do not na sa kanya tas meron kapang utang na malaki place a burden on a financially sound business Makikita dito ang recordkeeping at general 3. Sinking Fund Requirements- to provide business practices na need masunod ng issuer at for the systematic retirement of bonds prior to bond holder their maturity. To carry out this requirement, the corporation makes semiannual or annual 2. Restrictive Provisions or restrictive payments (need nya mapatunay na b4 maturity covenants- place operating and financial kaya nyan magbayad) that are used to retire bonds constraints on the borrower. These provisions help by purchasing them in the marketplace. protect the bondholder against increases in 4. Security Interest- any collateral pledged borrower risk. Without them, the borrower could against the bond. The protection of bond collateral increase the firm’s risk but no have to pay is crucial to guarantee the safety of a bond issue. increased interest to compensate for the increase Some bonds have collateral ex sa mortagage ang risk. collateral is the immovable props 5. Trustee- a third party to a bond Borrower Risk – possibility na hindi magbayad si indenture and can take specified actions on behalf issuer or si borrower on the bondholders if the terms of the indenture are violated. The most common restrictive covenants do the Pag nag breach of contract if hindi nagbayad or sa following: tamang process si borrower mo, si trustee 1) Require a minimum level of liquidity to gagawa ng paraan don (madalang lang) ensure against loan default Cost of Bonds to the Issuer Ung labas pasok ng pera ay mabilis lang, kase the longer the maturity, mas mabagal cash flow 1) Impact of Bond Maturity- The longer the 2) Prohibit the sale of accounts receivable maturity of a bond, the less accuracy there is in to generate cash. Selling receivables could cause a predicting future interest rates, and therefore the long-run cash shortage if proceeds were used to greater the bondholder’s risk of giving up an meet current obligations. opportunity to lend money at a higher rate. In In real life nangyayari to. ung cash flow ay ang addition, the longer the term, the greater the nagiging mabagal. Walang pumapasok na pera chance that the issuer might default. -magkakaron ng default the longer the maturity  BOND RATINGS - a letter-based credit scoring 2) Impact of Offering Size- Bond floatation scheme used to judge the quality and and administration costs per dollar borrowed are creditworthiness of a bond. likely to decrease with increasing offering size. On Parang good will pagandahan ng name the other hand, the risk to the bondholders may increase, because larger offerings result in greater 1) INVESTMENT GRADE BONDS – bond risk of default. rated triple B or higher, many banks and other - Talks abt loan value. Gaano kalaki ano ba institutional investor are permitted by law to hold factor ng loan value mo kung gaano ba kalaki only investment -grade bonds ung loan na inissue sa issuer naten Ito ung banko halos, sila ang permitted by law, - LOAN VALUE - Pag mas Malaki debt mas may standard worthiness and quality payment ng Mahirap bayaran binebenta nilang bond (eg. Sm, ayala – top corp) 3) Impact of Issuer’s Risk- (Issuer risk - the risk that the issuer of a financial product cannot Bond Prices meet the obligations it has entered into.) The Because most corporate bonds are purchased and greater the issuer’s default risk, the higher the held by institutional investors, such as banks, interest rate. Some of this risk can be reduced insurance companies, and mutual funds, rather through inclusion of appropriate restrictive than individual investors, bond trading and price provisions in the bond indenture. Clearly, data are bondholders must be compensated with higher returns for taking greater risk. COMMON TYPES OF BONDS - Same lang sa loan. High risk, high return UNSERCURED BONDS – walang collateral na 4) Impact of the Cost of Money- The cost of kapalit pag nag issue ka bond money in the capital market is the basis for determining a bond’s coupon interest rate. 1) DEBENTURE BONDS - is a type of bond or other debt instrument that is unsecured by BOND YIELDS – Unlike coupon rate (which is fixed), collateral. Since debentures have no collateral This Bond yield varies from day to day depending backing, they must rely on the creditworthiness on current market conditions. It also gives us the and reputation of the issuer for support. Both estimate rate of return we would earn if we corporations and governments frequently issue purchased the bond today and held in in future. debentures to raise capital or funds. - Parang coupon rate or interest rate. Sa CR Walang collateral, gov ang nag issue mostly neto. Fixed ang interest, sa bond yield nagbabago Meron silang pera na pambayad. Kung private, parang variable rate depends on current dipende. market conditions. 2) SUBORDINATED DEBENTURE BONDS - is a type of bond where the bondholder is at the a) YIELD TO MATURITY(YTM) – The rate of bottom of the repayment hierarchy if the return earned on bond if it is held to maturity. borrowing company faces bankruptcy. This means -Bibilin mo bond tas ihohold mo til maturity date that in such a situation, other loans with higher -Rate of return – percentage priority, known as senior unsubordinated bonds, b) YIELD TO CALL (YTC) – The rate of return get paid off before the subordinated bondholders earned on a bond when it’s called before maturity receive their payments. In other words, the date. You don’t have the option to hold it until subordinated bonds are riskier to hold compared maturity. to older, higher-priority bonds. -Rate of return that will earn b4 maturity date Kapag ang isang comp nag liquidate tas may kung cinall nya ito subordinate debenture bonds na utang, pinakahuli sya sa mabibigyan ng payments Note: Both will look for the RATE OF RETURN OR 3) INCOME BONDS – Payment of interest is PERCENTAGE. required only when earnings are available. Pinaka Malala kase pano pag walang earnings edi 7) EXTENDIBLE NOTES - a long-term debt walang payment ng interest na mangyayari security that includes an option that allows the bondholder to extend its initial maturity to a later SECURED BONDS – with collateral date. 1) MORTGAGE BONDS - is finance Madalang mag issue neto bc pag suki mona ung borrowed against immovable property, using that isang supplier or customer may palugit ka na property as security for the loan. Borrowed money ibibigay don kase parang consideration nalng for a property or real properties then serve it as collateral to the loan also. Ung collateral is ibang properties or ung immovable na property na binili mo mismo 2) COLLATERAL TRUST BONDS – Bonds secured by stocks or other bonds that owned by issuer. It is generally having 25-35% greater value than original issuing bonds. Ang collateral is bond mismo, pautang den or stock ng comp na nag issue, ang kalamangan is may 25-35 percent greater value. 3) EQUIPMENT TRUST BONDS - a bond secured by tangible property, such as airplane, equipment or physical assets. It is usually issued by a transportation company such as a railroad or shipping line to secure payment, as the title for the equipment is held in trust for the holders of the issue. - Like mortgage bonds, kaibahan ang movable prop at tangible prop ang collateral, mga Malaki like airplane, expensive car 4) PUTABLE BONDS– Bonds with provision that allows investor to sell them back to the company prior to maturity at a prearranged price. It allows investor to pay in advanced before maturity. May bonds ka na inissue sayo binili mo , pwedi mong ibalik sa kanila or ibenta sa kanila ang bonds 5) JUNK BONDS - a kind of bond or debt investment that is rated below investment grade. The junk bond rating means that there is a greater risk that the issuer will default on the debt relative to investment-grade bonds. Riskier din 6) FLOATING RATE BONDS - also known as variable rate bonds, are debt instruments where the interest rate periodically adjusts based on a reference rate on a specified market. Dipende san mo binili if local or international market don mag bbase ang interest rate , mag change periodically