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Lecture Fundamentals of finance – Chapter 6: Interest rates, bill and bond valuation

In this chapter, you will learn: Know the important bond features and bond types, understand bond values and why they fluctuate, understand bond ratings and what they mean, understand the impact of inflation on interest rates, understand the term structure of interest rates and the determinants of bond yields. | Chapter 6 Lecture – Interest Rates and Bond Valuation Chapter 6 Lecture – Interest Rates and Bond Valuation Learning Objectives After studying this chapter, you should be able to: LO1 Identify important bond features and types of bonds. LO2 Describe bond values and why they fluctuate. LO3 Discuss bond ratings and what they mean. LO4 Evaluate the impact of inflation on interest rates. LO5 Explain the term structure of interest rates and the determinants of bond yields. 6-1 6-2 General Features of Bonds Definition of a Bond • The bond’s principal, par value or face value is the amount borrowed by the company and the amount owed to the bond holder on the maturity date. • The bond’s maturity date is the time at which a bond becomes due and the principal must be repaid. • The bond’s coupon is the specified amount that must be periodically paid. • The coupon rate is the coupon divided by the principle • The bond’s current yield is the annual interest (income) divided by the current price of the security. The bond’s yield to maturity is the yield (expressed as a compound rate of return) earned on a bond from the time it is acquired until the maturity date of the bond. • Default risk: Risk that issuer will not make interest or principal payments. 6-4 Bond - evidence of debt issued by a corporation or a governmental body. A bond represents a loan made by investors to the issuer. In return for his/her money, the investor receives a legal claim on future cash flows of the borrower. The issuer promises to (a) • Make regular coupon payments every period until the bond matures, and • Pay the face/par/maturity value of the bond when it matures. 6-3 1 Chapter 6 Lecture – Interest Rates and Bond Valuation What’s the value of a 10-year, 10% coupon bond if i = 10%? The Mechanics of Bond Pricing • A fixed-rate bond is a contract detailing the par value, the coupon rate, and maturity date. • The coupon rate is close to the market rate of interest on similar bonds at the .