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Lecture

FNCE+2P91-Corporate+Finance-Notes-Chapter+7-Interest+Rates+and+Bond+Valuation.docx

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Department
Finance
Course
FNCE 2P91
Professor
Clarke Melville
Semester
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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