Chapter 8 Notes - Class.docx

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14 Apr 2012
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Professor
Chapter 8 Financing a Business with
Debt
Bonds
A contract or written agreement that allows a company to borrow a specific amount of money
at specified terms:
o Interest
o Principal
o Repayment date(s)
Can be exchanged on the open market
Unsecured bonds debentures
Serial bonds matures periodically over time
Term bonds mature all at the same time
Key Terminology
Face value
o refers to the actual principle amount of the bond, i.e. amount to be repaid@ maturity
“Stated Rate” or “Coupon Rate” or “Contract Rate” or “Face Rate”
o Rate of interest paid on the bond to the bondholders (i.e. sets the cash payment)
o PYNT = Face Value x Stated Rate
Market Rate
o Rate demanded by investors to lend money to the company (given similar risks, terms
etc.)
o Sets the effective rate or discount rate used to determine the Net Present Value of
future payments rec’cl (paid) from the bond
Price of the Bonds
o Present value of future payments discounted at the market rate
When the price of the bond is equal to its face value sold “at par”
When the price of the bond is greater than the face value sold “at premium”
When the price of the bond is less than the face value sold “at discount”
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Price (Proceeds) = PYNT x Present Value Annuity Factor r%, n + Principal x PVAFr%, n
Where r% = market rate of interest payment
Where n = number of interest payments
Bonds normally pay interest annually or semi-annually
A 10 year annual interest bond 10 interest payments (n=10)
A 10 year semi-annual interest bond 20 interest payments (n=20)
PYNT = Face Value x Stated Rate
Price of bonds is inversely related to the market rate
o As r% increases, PV decreases therefore Price of bonds decrease
o As r% decreases, PV increases therefore Price of bonds increase
If Price (Proceeds) < Face Value market rate > stated rate
If Price (Proceeds) > Face Value market rate < stated rate
If Price (Proceeds) = Face Value market rate = stated rate
SE8-9
a) Premium
b) Premium
c) Discount
Quoting Bond Prices
Bonds are quoted ( again newspapers)
Using a base value of 100
o Price of 100 Par Value
o Price < 100 Discount
o Price > 100 Premium
SE8-10
Halderman: Proceeds = 20,000 x 106% = 20,000 x 1.06 = 21,200
Erlichman: Proceeds = 100,000 x 99% = 100,000 x 0.99 = 99,000
Carl: Proceeds = $500,000 x 96.5% = 500,000 x 0.965 = 482,500
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