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University of Toronto Mississauga
Louis Florence

Class 4BondsCorporations and governments sometimes need to raise funds for various purposes in particular in order to invest in capital projectsbecause internally generated funds profits in the case of corporations and taxes in the case of governments may be insufficient in a particular periodHere we discuss the basic features of bondsA bond also called debenture is a legally binding agreement between a borrower the bond issuer and a lender the bondholder The agreement specifies the principal amount of the loan the timing and amount of the cash flows and any other provisionsOther provisions includecall options which allow the issuer to repurchase the bond at some point in time prior to the maturity dateput options which allow the bond holder to sell the bond back to the issuer at a designated price and timeconvertibility options which allow the bond holder to convert the bond into a certain specified number of shares of the companyA bond specifies a face amount F and a bond interest rate also called the coupon rate The bond also specifies a maturity date or term to maturity during which the coupons the bond interest payments are to be paid and the redemption amount to be paid on maturityBonds typically make coupon payments once per year Europe or semi annually United States Canada JapannnnPC1 1rrF1rCxPVIFAnrF1rThis is the formula for the price of a bond witheither annual coupon payments of amount C for n years where the effective annual rate of interest is given by rsemi annual coupon payments of C for n half years ie n2 years where the effective semi annual rate of interest is given by rFor example a bond with face value 1000 a 9 coupon rate and semi annual payments pays 45 every 6 months until maturity1
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