...time value of money in relation to corporate managers. Propose two (2) methods in which time value of money can help corporate managers in general. The time valuation of money is the idea that money available now could be worth more than the same amount in the future, because that current money has the possibility of earning money in the future. Think if the expression, “It takes money to make money!” If you are guaranteed to have $100.00 now or $100.00 in 3 years, you would probably take the money now. However, the $100.00 you could have now can be utilized to make even more money in the future through investing. This concept is very important in the business world as corporations are always looking to increase investing opportunities that will prove profitable. Time valuation enables corporate managers to determine two major aspects of investments; How much to invest and the rate of return on that investment. A company needs to know how much they need for an initial investment and how much that investment will yield over a given period of time. This is also where compounded interest plays a major role, the more the interest is compounded the greater the yield. Examine the pros and cons of a sinking fund from the viewpoint of both a firm and its bondholders. Determine the fundamental manner in which this knowledge could be helpful to a financial manager. Provide a rationale for your response. Sinking funds are a method of repaying funds that were borrowed via a bond. A...
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...Chapter 6 Bonds and their Valuation OVERVIEW This chapter presents a discussion of the key characteristics of bonds, and then uses time value of money concepts to determine bond values. Bonds are one of the most important types of securities to investors, and are a major source of financing for corporations and governments. The value of any financial asset is the present value of the cash flows expected from that asset. Therefore, once the cash flows have been estimated, and a discount rate determined, the value of the financial asset can be calculated. A bond is valued as the present value of the stream of interest payments (an annuity) plus the present value of the par value, which is the principal amount for the bond, and is received by the investor on the bond’s maturity date. Depending on the relationship between the current interest rate and the bond’s coupon rate, a bond can sell at its par value, at a discount, or at a premium. The total rate of return on a bond is comprised of two components: interest yield and capital gains yield. The bond valuation concepts developed earlier in the chapter are used to illustrate interest rate and reinvestment rate risk. In addition, default risk, various types of corporate bonds, bond ratings, and bond markets are discussed. Outline A bond is a long-term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond. There are four...
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...Bond Valuation By Anuj Joshi Note 1 Bond Valuation Fixed income paying securities. 1. Theoretical price or value of bond depends upon. i. Coupon Payment : Fixed amount of interest to be received after prescribed frequency. ii. Maturity Value [Unless otherwise given is exam, we should take face value] iii. Discount Rate : It should always be market interest rate 2. What is market interest rate Market interest rate is derived from comparable listed bond. The comparison is based on risk and life of the bond. E.g. If we are valuing a bond which is unlisted and have 5 years of life, then we should look for a bond which is similar in risk profile (i.e. same credit rating)and having similar life. The YTM (Yield to Maturity) of listed bond is called market interest rate The YTM of a bond is nothing but IRR of the bond. 3. Value of a bond = PV of Coupon Amount + PV of Maturity Value [Remember CF and discount rate are before tax] Concept Point: i. Coupon rate is a historical rate and should never be used as a discount rate. In exam, if no other information is available, then only we should assume coupon rate of interest as market rate of interest. ii. Remember, Cost of Capital or Discount Rate is a future concept and it represents opportunity cost on the date of valuation. iii. YTM of a similar bond (i.e. current market interest rate) is the appropriate discount rate for bond valuation. How to value a bond which pays interest at a frequency lower than annually (e...
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...Lecture 4: Bond Market and Bond Valuation GMBA 609: Managerial Finance Dr Anthony Owusu-Ansah aowusu-ansah@gimpa.edu.gh GIMPA Business School October 2014 Dr Owusu-Ansah (GIMPA Business School) Lecture 4: Bonds October 2014 1 / 49 Learning Objectives At the end of this session, you should be able to: De…ne and understand the basic mechanisms of the bond market Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. Describe the legal aspects and the features of di¤erent types of bonds. Apply the basic valuation model to bonds, and describe the impact of required return and time to maturity on bond values. Explain yield to maturity (YTM), its calculation, and the procedure used to value bonds that pay interest semiannually. Dr Owusu-Ansah (GIMPA Business School) Lecture 4: Bonds October 2014 2 / 49 Types of Loans Pure Discount Loan Interest-only Loan Amortized with Fixed Principal payment Amortized with Fixed Payment Dr Owusu-Ansah (GIMPA Business School) Lecture 4: Bonds October 2014 3 / 49 Pure Discount Loans Treasury bills are excellent examples of pure discount loans. The principal amount is repaid at some future date, without any periodic interest payments. Dr Owusu-Ansah (GIMPA Business School) Lecture 4: Bonds October 2014 4 / 49 Pure Discount Loans...con’ t Problem If a T-bill promises to repay $10,000 in 12 months and the market interest rate is 7 percent, how much...
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...Chapter 4: mini case a. What are the key features of a bond? • Par Value • Coupon Rate • Maturity Date • Provisions to Call or Redeem Bonds • Issue Date • Default Risk b. c. What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky? Bonds that have call provisions allow the firms who issued the bonds to recall (redeem) them back. However, sinking fund provisions allows firms to retire funds in an orderly manner. Firms can retire funds by two ways: 1) they can call in a percentage of bonds each year or 2) they can buy them through the open market. d. How is the value of an asset whose value is based on expected future cash flows determined? It is determined by the present value of all future cash flows the assets will generate. e. How is the value of a bond determined? What is the value of a 10yr, $1000 par value bond with a 10% annual coupon if its required rate of return is 10%? The value of a bond is determined by using the following equation: V b= INT / (1+ rd) 1 + INT / (1+ rd) 2 + … + INT / (1+ rd) n The value of a bond with a 10yr maturity, $1,000 par, 10% coupon rate, and a required rate of 10% is $1000. Hence, the coupon is equal to the required rate; therefore, it’s equal to its par value. |N |PMT |Required |FV |PV | |10 ...
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...Chapter 4 Answers to Concept Review Questions 1. Managers need to understand how bonds and stocks are priced because (1) firms regularly issue stocks and bonds to raise money for investment (2) understanding how securities are priced is helpful when conducting an acquisition or a divestiture, (3) the stock price is an objective signal of how managers are performing, and (4) finance theory teaches that the goal of the manager should be to maximize the firm’s stock price. 5. The coupon rate equals the annual coupon payment divided by par value. The coupon yield equals the annual coupon payment divided by the bond’s market price. 6. A bond sells at a discount when the bond’s coupon rate is lower than the market’s required rate of return on the bond. 11. An issuer benefits from an option to call a bond, because such an option allows the issuer to lock in a more favorable interest rate if rates should fall.. The option to convert bonds into common stock benefits bondholders. Once the stock price rises high enough, the value of the bonds starts to behave like the stock’s value—the prices start to rise. So convertible bonds offer investors some minimal level of return plus a lot of upside potential. 13. The price of a Treasury note quoted as 98:10 is 98 10/32 percent of par value or $983.125. Answers to End-of-Chapter Questions Q4-1. What is the relationship between the price of a financial asset and the return that investors require on that asset, holding...
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...VALUATION OF BONDS Valuation Value of financial securities = PV of expected future cash flows To value bonds and stocks we need to: Estimate future cash flows: Size (how much) and Timing (when) Discount future cash flows at an appropriate rate: The rate should be appropriate to the risk presented by the security. Indian Debt Market Consists of mainly two categories: the government securities comprising central government and state government securities, the corporate bond market consists of financial institutions (FI) bonds, public sector units (PSU) bonds, and corporate bonds/debentures. The government securities are the more dominant category of debt markets Bonds Bonds provide a fixed return to the holder Bonds vs Debentures Types: Convertible and Non convertible Coupon and Zero Coupon Key Features of a Coupon Bond Par value or Face value: Rs 1,000 or Rs 100 (usually) Issue Price is generally equal to the par value Market Price: After issue, the price of the bond in the market fluctuates according to changes in interest rates (the face value remains fixed) Coupon interest rate: Stated interest rate. (Multiply by par value to get the interest amount) Maturity: Years until bond must be repaid. Maturity Value: generally same as the par value, but may be different, i.e. either higher or lower than par value VALUE OF A BOND ...
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...Chapter 7(13E) Bonds and Their Valuation Answers to End-of-Chapter Questions 7-1 From the corporation’s viewpoint, one important factor in establishing a sinking fund is that its own bonds generally have a higher yield than do government bonds; hence, the company saves more interest by retiring its own bonds than it could earn by buying government bonds. This factor causes firms to favor the second procedure. Investors also would prefer the annual retirement procedure if they thought that interest rates were more likely to rise than to fall, but they would prefer the government bond purchase program if they thought rates were likely to fall. In addition, bondholders recognize that, under the government bond purchase scheme, each bondholder would be entitled to a given amount of cash from the liquidation of the sinking fund if the firm should go into default, whereas under the annual retirement plan, some of the holders would receive a cash benefit while others would benefit only indirectly from the fact that there would be fewer bonds outstanding. On balance, investors seem to have little reason for choosing one method over the other, while the annual retirement method is clearly more beneficial to the firm. The consequence has been a pronounced trend toward annual retirement and away from the accumulation scheme. 7-2 Yes, the statement is true. 7-3 False. Short-term bond prices are less sensitive than long-term bond prices to interest rate changes...
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...Chapter STUDY OBJECTIVES After studying this chapter, you should be able to: 1 Explain a current liability, and identify the major types of current liabilities. 2 Describe the accounting for notes payable. 3 Explain the accounting for other current liabilities. 4 Explain why bonds are issued, and identify the types of bonds. 5 Prepare the entries for the issuance of bonds and interest expense. 6 Describe the entries when bonds are redeemed or converted. 7 Describe the accounting for long-term notes payable. 8 Identify the methods for the presentation and analysis of long-term liabilities. ✓ The Navigator Scan Study Objectives Read Feature Story Read Preview Read text and answer p. 453 p. 465 ■ ■ ■ ■ ■ p. 458 ■ Do it! p. 461 Do it! ■ p. 463 ■ ■ ■ ■ ■ Work Comprehensive p. 469 Review Summary of Study Objectives Answer Self-Study Questions Complete Assignments ✓ The Navigator Feature Story FINANCING HIS DREAMS What would you do if you had a great idea for a new product, but couldn’t come up with the cash to get the business off the ground? Small businesses often cannot attract investors. Nor can they obtain traditional debt financing through bank loans or bond issuances. Instead, they often resort to unusual, and costly, forms of nontraditional financing. Such was the case for Wilbert Murdock. Murdock grew up in a New York housing project, and always had great ambitions. This ambitious spirit led him into some business ventures that...
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...4 Define the following terms: bond indenture, par value, principal, maturity, call provision, and sinking fund. Bond indenture. Bond indenture is a legal contract for a publicly traded bond. The structure of this contract outline incentives explicitly by detailing responsibilities, constraints, penalties, and oversight required. For example, contracts may specify interest and principal payment timing and amounts. Par value. Par value denotes face value or designated value of a bond or stock. Par value of a bond is typically $1,000 and the sum investors pay upon issue. It is also the sum received when they redeem the bond matures. Conversely, stock par value is frequently set at $1. In this case, par value is an accounting tool that shows no connection to the stocks’ market value. Principal. The term “principal” refers to a sum of money one borrows or invests. The face amount of a bond - the value printed on a stock or bond, or a debt balance. Principal does not encompass finance charges. Principal also describes an investor represented by a broker who executes trades on that investor’s behalf or an investor who trades for his or her own benefit. Principal also refers to a party affected by an agent’s decisions in a principal-agent relationship. Maturity. Maturity is the end of a bond’s life. In finance, maturity (or maturity date) designates the date of final payment on a financial instrument. Maturity value is the amount of money the bond issuer must repay at the end of...
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...accounts are _________ but are not _________.| A)|negotiable; liquid.| B)|marketable; liquid.| C)|liquid; personal| D)|liquid; marketable| Ans:|D| 4.|Series EE bonds must be held at least ______ years in order to receive the guaranteed minimum rate.| A)|3| B)|5| C)|8| D)|10| Ans:|B| 5.|Treasury bills are traded in the _____________________.| A)|money market.| B)|capital market.| C)|government market.| D)|regulated market.| Ans:|A| 6.|Which of the U.S. Treasury securities is always sold at a discount?| A)|Treasury bills| B)|Treasury notes| C)|Treasury bonds| D)|All of the Treasury securities are sold at a discount.| Ans:|A| 7.|Which of the following statements regarding money market instruments is not true?| A)|They tend to be highly marketable.| B)|They tend to require a small dollar investment.| C)|They tend to have a low probability of default.| D)|Their rates tend to move together.| Ans:|B| 8.|Which of the following would not be considered a capital market security?| A)|a 20-year corporate bond| B)|a common stock| C)|a 6-month Treasury bill| D)|a mutual fund share| Ans:|C| 9.|The coupon rate is another name for the:| A)|market interest rate.| B)|current yield.| C)|stated interest rate.| D)|yield to maturity| Ans:|C| 10.|Zero-coupon bonds are similar to Treasury bills in that both:| A)|are issued exclusively by the U.S. Treasury.| B)|are money-market securities.| C)|are capital-market...
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...Bond Yields Interest rates have a big part in determining the yield of a bond. If interest rates rise, the bond will be worth less and if they fall bonds will be worth more. The Yield to Maturity or YTM is the rate of return the lender or borrower will earn if the bond is not sold before its maturity. It can be also referred to as the bond`s yield. In order to be able to calculate the Yield to Maturity, some of the things you would need to know are the current price, the par value, the interest payments, and the maturity date for the bond. A coupon is the stated interest payment made on a bond. The market value will be less than par value if the required rate of return is above the coupon interest rate. Bond will be valued above pay value if the required rate of return is below the coupon interest rate. Also, the lower the coupon rate the greater the interest rate risk. Interest rate risk refers to the risk of fluctuating interest rates. In other words, bond values have an inverse relationship to interest rates. Long-term bonds will have a greater interest rate risk than short-term bonds. Interest rates have a greater impact on long-term bonds because it takes longer for them to mature. Typically, the more you can earn from a bond the more risk there is to it. However, the more risk there is to a bond the more likely either the borrower might default. Bonds have a rating system which gives them a rating based on the likelihood...
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...Week 7 Homework 1. A. Find the face value of a $3000 bond issued at 10% for 5 years? =PV(10%,5,300,3000) =3000 B. If the market Interest rate increases to 12%, what is the new value of the bond? =PV(12%,5,300,3000,0) =$2,783.71 C. If the market interest rate decreases to 8%, what is the new price of the bond? =PV(8%,5,300,3000,0) =$3,239.56 2. Find the Face value of a $1000 bond issued at 12% for 10 years? =PV(0.12,10,120,1000,0) =$1,000.00 B. If the market Interest rate increases to 15%, what is the new value of the bond? =PV(0.15,10,120,1000,0) =$849.44 C. If the market interest rate decreases to 7%, what is the new price of the bond? =PV(0.07,10,120,1000,0) =$1,351.18 3. If you buy a callable bond and interest rate decline, will the value of your bond rise by as much as it would have risen if the bond had NOT been callable? If interest rate decline in the market, the value of callable bonds will not rise as much as regular bond (bonds with no call option). The reason is that issuer of bonds has option to redeems the bond any time and when interest rate decline in the market this is the perfect time for them to redeem the bonds with high interest rate and issue new bonds with low prevailing market interest rate. 4. A sinking fund can be set up in one of two ways. Discuss the advantages and disadvantages of each procedure from the view point of both the firm and its bondholders, ...
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...Principles of Accounting Chapter 10 Preview of Ch. #10 2 Current Liabilities Current liability • A debt that the company expects to pay within one year or the operating cycle, whichever is longer. • Most companies pay current liabilities by using current assets. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable. 3 Current Liabilities Question The time period for classifying a liability as current is one year or the operating cycle, whichever is: a. longer b. shorter c. probable d. possible 4 Current Liabilities Notes Payable • Recorded obligation in the form of written notes. • Usually require the borrower to pay interest. • Issued for varying periods of time. • Those due for payment within one year of the statement of financial position date are usually classified as current liabilities. 5 Current Liabilities Illustration: Hong Kong National Bank agrees to lend HK$100,000 on September 1, 2014, if C.W. Co. signs a HK$100,000, 12%, four-month note maturing on January 1. Instructions a) Prepare the journal entry on September 1. b) Prepare the adjusting journal entry on December 31, assuming monthly adjusting entries have not been made. c) Prepare the journal entry at maturity (January 1, 2015). 6 Current Liabilities Illustration: Hong Kong National Bank agrees to lend HK$100,000...
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...within one year. Commonly, these accounts contain stocks and bonds that are considered highly liquid assets. Example- Investing money for going in a vacation within a year, investing in company’s yearly inventories. * Medium term: An intermediate duration asset holding period or investment horizon. The exact time period to be considered as medium term depends on the investor's personal choices, as well as on the asset class under consideration. Bonds that have a maturity period of between 5 to 10 years are considered to be intermediate -term bonds In the fixed-income market. Example – Investing money for buying a house in 5 years, investing in machineries which will last for 5 years. * Long Term Investments: The account on the asset side of the balance sheet of any company which represents the investments that the company intends to hold for more than ten year. It includes real estate, stocks, bonds and cash. Example – Investing money in retirement scheme benefits, investing in long term assets of factories. Measurement of duration: * Effective duration can be defined as the percentage change in security’s price that results from a change in yield of 100 basis points. e.g. - The price of a bond with an effective duration of 2 years will rise 2% for every 1% decrease in the yield. Similarly the price of a bond with duration of 5 years will rise 5% for a 1% decrease in the yield. As interest rates and bond yields are directly correlated, the longer the...
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