1. Intro to Financial Management
Bonds

2. Review Homework Expected rate of return Required rate of return
Risk-free rate of return
Market rate of return
Systemic and idiosyncratic risk
Beta?
CAPM

3. Review What is “the time value of money?”
How do you calculate and what do these mean?
Compounding interest
PV, FV (incl. solving for n)
Different flows
Non-annual periods
Simple annuity (PV?)
Amortized loans
APR
Perpetuity

4. Bonds A bond is basically an IOU Characteristics
Coupon rate
Predetermined, fixed amount of interest
Paid semi-annually
Maturity date
Par Value
Amount owed at maturity (normally $1000)
Prices are given as a % of par (face) value
E.g. bond at 125 can be bought at 125% of its par value
May be callable (redeemable)
Claim on assets

5. Types of Bonds Corporate Government Eurobonds Sovereign debt
Debenture – unsecured
Subordinated debentures – comes after debentures if insolvent
Secured
Government
U.S Treasury Bonds
Municipal Bonds (munis)
General obligation
Revenue
Eurobonds
Sovereign debt
Convertible
Mortgage bonds

6. Bond Ratings Companies rate the creditworthiness of bonds
Standard & Poor’s (S&P)
Moody’s
Fitch
Typical ratings scale
AAA AA A
BBB
BB BB and below are “junk” bonds (also called “high yield”) B
CCC …
D in default

7. Value Book value – shown in the financial statements
Liquidation value – value if assets were sold
Market value
Intrinsic / economic value
PV of future expected cash flows
PV of future cash flows affected by
Amount and timing of payments
Riskiness of payments
Required rate of return

8. Ci is cash flow in period i n = time to maturity
PV of Future Cash Flows
Ci is cash flow in period i
n = time to maturity
r = required rate of return
Exercise - Compute value of example bonds.

9. Bond Yields Yield to maturity Current yield
Expected rate of return
Use market price for PV
Use par value for FV
Use coupon interest rate for payments
Current yield
Interest payment / price
Use to compare to alternative investments

10. Bond Risk Default risk Interest rate risk Inflation risk Maturity
Will affect your required rate of return to take on the risk
Interest rate risk
If goes up, then required rate of return goes up
If retired rate of return goes up, price goes down
Inflation risk
Maturity
The longer the maturity, the higher the risk
Why?

11. Bond Prices
Price will be below par if required rate of return is above coupon interest rate
And vice versa
Inverse relationships between bond prices and
Market interest rates
Inflation

12. Yield Curve