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Finance

FNCE 2P91

Clarke Melville

Winter

Description

FNCE 2P91 - Section 05
Winter 2011 - Duration 03
08.02.11
FNCE 2P91: Corporate Finance-Notes-Chapter 7: Interest Rates and Bond
Valuation
Notes
ANSWERS TO PRACTICE PROBLEMS
Questions were attached with email on class cancelation
1. MRS KESEL
0 1 2 28 29 30 31 32 54
C C C C C 100 000 100 000
Point of Reference
r 10%
[( ) ( ) [ ] ( )
Try solving with a different point of reverence
2. ANOTHER PREVIOUS EXAM QUESTION
0 1 2 3 4 5 16 17 48
1500 1500 1500 1500 1500
16% 12%
PV of 2 Sets of Cash Flows
( ) ( )
[ ]( ) [ ]( )
WHAT DO I MEAN WHEN I SAY “DISCOUNT IT BACK”?
Think of the PV of annuity of $1000 payment at 10% interest for 10 years, payment one year from now
0 1 2 3 10
1000 1000 1000 1000
[ ( ) ]
Part Two:
Same as above but annuity does not start until year 4
0 1 2 3 4 5 6 10
1000 1000 1000 FNCE 2P91 - Section 05
Winter 2011 - Duration 03
To find PV take PV of annuity until t=3 then “discount back” to time 0
( )
[ ]( )
Discounts cash flow back three periods to t=0
3. PREVIOUS MIDTERM QUESTION FROM LAST YEAR
Weekly mortgage payment?
t 20 years x 52 weeks = 1040 payments
APR 4.95%
[ ( ) ]
[ ]
( )
[ ]
Part B:
20 years – 7 years = 13 years left x 52 weeks = 676 payments left
( )
[ ]
Slides for Chapter 7 have been posted on Sakai
Bond Definitions 7.1
Bond
Par value (face value)
Coupon rate
Coupon payment
Maturity date
Yield or Yield to maturity
1. Corporation issues bond to Investor
2. Each year the Corporation will pay interest
payments or “Coupon Payments”
Corporation Investor
3. Corporation repays principle at the end of
Bond Life
4. Investor lends Corporation some money
Corporation wants to raise money it can issue bonds FNCE 2P91 - Section 05
Winter 2011 - Duration 03
TERMS:
Face value is the amount to be paid back at end of issue; for this class: typically $1000
Coupon rate is the annual payment typically expressed as a percent of the face value
For example 10% coupon rate = annual interest payment of 10% x 1000 = $100
$100 coupon payment
Maturity date is the length (in years) of the bond until face value repaid
10 years example 10 years
So for above investor would receive 10 payments at $100 each year plus the repayment of face value
YTM (Yield to maturity) is the interest rate or “yield” investor earns if they hold bond until maturity
PRESENT VALUE OF CASH FLOWS AS RATES CHANGE
Bond value = PV of coupons + PV of face
Bond value = PV annuity + PV of lump sum
Remember, as interest rates increase the PV’s decrease and vice versa
So as interest rates increase, bond prices decrease and vice versa
VALUING A DISCOUNT BOND WITH ANNUAL COUPONS
Question
Consider a bond with a coupon rate of 10% and coupons paid annually. The par value is $1000 and the
bound has 5 years to maturity. The yield to maturity is 11%. What is the value of the bond?
Answer:
Using the formula:
( )
[ ]

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