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FIN 302 Lecture Notes - Lecture 9: Cash Flow, Investment

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School
University of Miami
Department
Finance Business Administration
Course
FIN 302
Professor
Peterson

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Document Summary

Vanilla bonds: coupon payments fixed for the life of the bond repay principal and retire the bonds at maturity, contracts have the features and provisions found in most bond covenants, annual or semiannual coupon payments. Bond valuation: determine the require rate of return, determine expected future cash flows the coupon payments and face value, compute the current market value, or price by calculating the present value of the expected cash flows. Semiannual coupons: most bonds issued in europe pay annual coupons, most issued in the us pay semiannual coupons. If a (cid:271)o(cid:374)d"s (cid:272)oupo(cid:374) (cid:396)ate is e(cid:395)ual to its (cid:455)ield, its p(cid:396)i(cid:272)e e(cid:395)uals its fa(cid:272)e (cid:448)alue. If a (cid:271)o(cid:374)d"s (cid:272)oupo(cid:374) (cid:396)ate is less tha(cid:374) its (cid:455)ield, the p(cid:396)i(cid:272)e is less than face value. If a (cid:271)o(cid:374)d"s (cid:272)oupo(cid:374) (cid:396)ate is g(cid:396)eate(cid:396) tha(cid:374) its (cid:455)ield, its p(cid:396)i(cid:272)e is g(cid:396)eate(cid:396) tha(cid:374) its fa(cid:272)e (cid:448)alue.

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Related Questions

QUESTION 1 The largest investors in corporate bonds are life insurance companies and pension funds. True False 5 points QUESTION 2 Most secondary market transactions for corporate bonds take place through dealers in the over-the-counter (OTC) market. True False 5 points QUESTION 3 The value (or price) of a bond is the present value of its expected future cash flows. True False 5 points QUESTION 4 Bond prices decline when the interest rate decreases. True False 5 points QUESTION 5 The face or par value for bonds is the amount paid to bondholders at maturity and is usually equal to $1,000. True False 5 points QUESTION 6 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond. True False 5 points QUESTION 7 Zero coupon bonds have no coupon payments so they sell for more than their par value. True False 5 points QUESTION 8 Interest rate risk is the risk that bond prices will fluctuate when the interest rate changes. True False 5 points QUESTION 9 US Treasury securities are considered risky investments because the coupon payments are unpredictable. True False 5 points QUESTION 10 Bonds are very difficult to value because their future cash flows are very difficult to predict. True False 5 points QUESTION 11 If the bond's coupon rate is equal to the market rate then the bond will sell at a price equal to its face value greater than its face value less than its face value equal to its foreign currency value, e.g., its price in British pounds 5 points QUESTION 12 When calculating the price of a bond that pays a semiannual coupon one needs to use double the number of years until maturity for the number of payments use half the annual coupon payment use half the annual rate of return as the discount rate all of the above 5 points QUESTION 13 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments more than the price of the bond equal to zero equal to the price of the bond less than the price of the bond 5 points QUESTION 14 Which one of the following statements is true? All else equal long-term bonds have lower price volatility than short-term bonds. There is an inverse relation between bond prices and market interest rates. All else equal short-term bonds are more risky than long-term bonds. All else equal US government bonds are more risky than corporate bonds. 5 points QUESTION 15 An investor owns a 10-year US government bond with a 9 percent coupon rate. If the yield-to-maturity on the bond is 8 percent then this bond is selling for its par value. a discount. a premium. its face value. 5 points QUESTION 16 BA Corp is issuing a 10-year bond with a coupon rate of 8 percent and a par value of $1,000. The market interest rate on similar bonds is currently 6 percent. If the coupon payments are made annually, what is the value of this bond? 5 points QUESTION 17 Knight, Inc. has issued a 3-year bond with a $1,000 par value and an annual coupon rate of 6 percent. The current market rate of interest is 5 percent. What is the value of this bond if the coupon payments are made semiannually? 5 points QUESTION 18 Diane Carter is interested in buying a 5-year zero coupon bond with a face value of $5,000. If the market interest rate on these types of bonds is currently 9 percent, what is the current price of this bond? 5 points QUESTION 19 Rudy Sandberg wants to invest in 4-year bonds that are currently priced at $933.76. The bonds have a coupon rate of 6 percent and annual coupon payments. If the par value of the bonds is $1,000, what is the bond's yield-to-maturity? 5 points QUESTION 20 You own a 5-year bond with a face value of $1,000 and a coupon rate of 5 percent with annual payments. The bond is currently worth $810.46. If market interest rates remain unchanged, what will be the value of the bond next year when there are 4 years left until maturity?

The (-Select- A. discount B. premium C. par) value of a bond is its stated face value or maturity value, and its coupon interest rate is the stated annual interest rate on the bond. The maturity date is the date on which the par value must be repaid. A (-Select- A. call B. redemption C. sinking) provision gives the issuer the right to redeem the bonds under specified terms prior to their normal maturity date, although not all bonds have this provision. Some bonds have (-Select- A. redemption fund B. sinking fund C. call fund) provisions which require the issuer to systematically retire a portion of the bond issue each year. Because sinking fund provisions facilitate their orderly retirement, bonds with these provisions are regarded as being (-Select-A. riskier B. safer C. equivalent) so they will have (-Select- A. lower B. equivalent C. higher) coupon rates than similar bonds without these provisions.

Bonds can be (-Select- A. floating B. zero C. fixed) -rate bonds with a constant coupon rate over the life of the bond, or they can be (-Select- A. floating B. zero C. fixed) -rate bonds with a coupon rate that varies over time depending on the level of interest rates. (-Select- A. Annual coupon B. Zero coupon C. Fixed coupon) bonds pay no annual interest but are sold at a (-Select- A. premium above B. price at C. discount below) par, thus compensating investors in the form of capital appreciation. An original issue discount (OID) bond is any bond originally offered at a price (-Select- A. above its B. below its C. equal to) par value.

(-Select- A. Convertible B. Perpetual C. Putable) bonds are exchangeable at the option of the holder for the issuing firm's common stock. Bonds can be issued with warrants giving the holder the option to purchase the firm's stock for a stated price, thereby providing a capital gain if the stock's price rises. (-Select- A. Income B. Convertible C. Putable) bonds contain a provision that allows holders to sell them back to the company prior to maturity at a prearranged price. (-Select- A. Income B. Default C. Preferred) bonds pay interest only if the firm has earnings, while an indexed (purchasing power) bond bases interest payments on an inflation index to protect the holder from inflation.

Mortgage bonds are backed by (-Select- A. current assets B. fixed assets C. marketable securities) . First mortgage bonds are senior in priority to claims of second mortgage bonds. Debentures are long-term bonds that are not secured by a mortgage. Subordinated debentures are bonds having claims on assets only after senior debt has been paid in full in the event of liquidation. (-Select- A. Secured-debenture B. Investment-grade) bonds are rated triple B or higher, and many banks and other institutional investors are legally limited to only holding these bonds. In contrast, junk bonds are high-risk, high-yield bonds.

Manjit Mittal, CFO, India Steel Industries Corp., is consideringissuance of convertible bonds. The bonds will be of 30-yearmaturity and will have a coupon rate of 9.75 percent, par value of$1,000, and will be sold at a price of $1,075 (this is Vpackagefrom the lecture slides). The convertible bonds will have a 6-yearcall protection and the call price is $1,150. The conversion ratiois 25 on par value basis. The company’s stock is currently sellingat $30 a share. The company paid a dividend of $2.00 last year andthe dividends are expected to grow at a constant 6.0 percent rateinto the foreseeable future. The company’s straight bonds have a12.5 percent coupon rate. Assume semi-annual coupon payments inyour computations.

(a) What is the convertible’s straight bond’s value? What is theimplied value of the convertible feature?
(b) What will be the floor value of the bond at the end of year 7?Assume that straight bonds of comparable risk will haveyield-to-maturity = 11.5 percent at that time (hint: this suggestswhat rd is at that time).
(c) Assuming full conversion of bonds into stock at the end of 8½years. What will be the firm’s actual cost of capital for thisissue of convertible bonds?
(d) Did the company gain or lose by issuing bonds with conversionfeature, as opposed to issuing straight bonds? What motivated theinvestors to buy bonds at a lower coupon rate of 9.75% when bondsof comparable risk were offering 12.50%? Explain.