公司理财第十版课件

Chapter7 InterestRatesandBondValuationMcGraw-Hill/IrwinCopyright©2013byTheMcGraw-HillCompanies,Inc.Allrightsreserved. Chapter7McGraw-Hill/IrwinCopKeyConceptsandSkillsKnowtheimportantbondfeaturesandbondtypesUnderstandbondvaluesandwhytheyfluctuateUnderstandbondratingsandwhattheymeanUnderstandtheimpactofinflationoninterestratesUnderstandthetermstructureofinterestratesandthedeterminantsofbondyields7-2KeyConceptsandSkillsKnowthChapterOutlineBondsandBondValuationMoreaboutBondFeaturesBondRatingsSomeDifferentTypesofBondsBondMarketsInflationandInterestRatesDeterminantsofBondYields7-3ChapterOutlineBondsandBondBondDefinitionsBondParvalue(facevalue)CouponrateCouponpaymentMaturitydateYieldorYieldtomaturity7-4BondDefinitionsBond7-4PresentValueofCashFlows

asRatesChangeBondValue=PVofcoupons+PVofparBondValue=PVofannuity+PVoflumpsumAsinterestratesincrease,presentvaluesdecreaseSo,asinterestratesincrease,bondpricesdecreaseandviceversa7-5PresentValueofCashFlows

aValuingaDiscountBondwithAnnualCouponsConsiderabondwithacouponrateof10%andannualcoupons.Theparvalueis$1,000,andthebondhas5yearstomaturity.Theyieldtomaturityis11%.Whatisthevalueofthebond?Usingtheformula:B=PVofannuity+PVoflumpsumB=100[1–1/(1.11)5]/.11+1,000/(1.11)5B=369.59+593.45=963.04Usingthecalculator:N=5;I/Y=11;PMT=100;FV=1,000CPTPV=-963.047-6ValuingaDiscountBondwithAValuingaPremiumBondwithAnnualCouponsSupposeyouarereviewingabondthathasa10%annualcouponandafacevalueof$1000.Thereare20yearstomaturity,andtheyieldtomaturityis8%.Whatisthepriceofthisbond?Usingtheformula:B=PVofannuity+PVoflumpsumB=100[1–1/(1.08)20]/.08+1000/(1.08)20B=981.81+214.55=1196.36Usingthecalculator:N=20;I/Y=8;PMT=100;FV=1000CPTPV=-1,196.367-7ValuingaPremiumBondwithAnGraphicalRelationshipBetweenPriceandYield-to-maturity(YTM)BondPriceYield-to-maturity(YTM)7-8GraphicalRelationshipBetweenBondPrices:RelationshipBetweenCouponandYieldIfYTM=couponrate,thenparvalue=bondpriceIfYTM>couponrate,thenparvalue>bondpriceWhy?ThediscountprovidesyieldabovecouponratePricebelowparvalue,calledadiscountbondIfYTM<couponrate,thenparvalue<bondpriceWhy?HighercouponratecausesvalueaboveparPriceaboveparvalue,calledapremiumbond7-9BondPrices:RelationshipBetwTheBondPricingEquation7-10TheBondPricingEquation7-10Example7.1FindpresentvaluesbasedonthepaymentperiodHowmanycouponpaymentsarethere?Whatisthesemiannualcouponpayment?Whatisthesemiannualyield?B=70[1–1/(1.08)14]/.08+1,000/(1.08)14=917.56OrPMT=70;N=14;I/Y=8;FV=1,000;CPTPV=-917.567-11Example7.1FindpresentvaluesInterestRateRiskPriceRiskChangeinpriceduetochangesininterestratesLong-termbondshavemorepriceriskthanshort-termbondsLowcouponratebondshavemorepriceriskthanhighcouponratebondsReinvestmentRateRiskUncertaintyconcerningratesatwhichcashflowscanbereinvestedShort-termbondshavemorereinvestmentrateriskthanlong-termbondsHighcouponratebondshavemorereinvestmentrateriskthanlowcouponratebonds7-12InterestRateRiskPriceRisk7-Figure7.27-13Figure7.27-13ComputingYieldtoMaturityYieldtoMaturity(YTM)istherateimpliedbythecurrentbondpriceFindingtheYTMrequirestrialanderrorifyoudonothaveafinancialcalculatorandissimilartotheprocessforfindingrwithanannuityIfyouhaveafinancialcalculator,enterN,PV,PMT,andFV,rememberingthesignconvention(PMTandFVneedtohavethesamesign,PVtheoppositesign)7-14ComputingYieldtoMaturityYieYTMwithAnnualCouponsConsiderabondwitha10%annualcouponrate,15yearstomaturityandaparvalueof$1,000.Thecurrentpriceis$928.09.Willtheyieldbemoreorlessthan10%?N=15;PV=-928.09;FV=1,000;PMT=100CPTI/Y=11%7-15YTMwithAnnualCouponsConsideYTMwithSemiannualCouponsSupposeabondwitha10%couponrateandsemiannualcoupons,hasafacevalueof$1,000,20yearstomaturityandissellingfor$1,197.93.IstheYTMmoreorlessthan10%?Whatisthesemiannualcouponpayment?Howmanyperiodsarethere?N=40;PV=-1,197.93;PMT=50;FV=1,000;CPTI/Y=4%(IsthistheYTM?)YTM=4%*2=8%7-16YTMwithSemiannualCouponsSupTable7.17-17Table7.17-17CurrentYieldvs.YieldtoMaturityCurrentYield=annualcoupon/priceYieldtomaturity=currentyield+capitalgainsyieldExample:10%couponbond,withsemiannualcoupons,facevalueof1,000,20yearstomaturity,$1,197.93priceCurrentyield=100/1,197.93=.0835=8.35%Priceinoneyear,assumingnochangeinYTM=1,193.68Capitalgainyield=(1,193.68–1,197.93)/1,197.93=-.0035=-.35%YTM=8.35-.35=8%,whichisthesameYTMcomputedearlier7-18CurrentYieldvs.YieldtoMatBondPricingTheoremsBondsofsimilarrisk(andmaturity)willbepricedtoyieldaboutthesamereturn,regardlessofthecouponrateIfyouknowthepriceofonebond,youcanestimateitsYTMandusethattofindthepriceofthesecondbondThisisausefulconceptthatcanbetransferredtovaluingassetsotherthanbonds7-19BondPricingTheoremsBondsofBondPriceswithaSpreadsheetThereisaspecificformulaforfindingbondpricesonaspreadsheetPRICE(Settlement,Maturity,Rate,Yld,Redemption,Frequency,Basis)YIELD(Settlement,Maturity,Rate,Pr,Redemption,Frequency,Basis)SettlementandmaturityneedtobeactualdatesTheredemptionandPrneedtobeinputas%ofparvalueClickontheExceliconforanexample7-20BondPriceswithaSpreadsheetDifferencesBetween

DebtandEquityDebtNotanownershipinterestCreditorsdonothavevotingrightsInterestisconsideredacostofdoingbusinessandistaxdeductibleCreditorshavelegalrecourseifinterestorprincipalpaymentsaremissedExcessdebtcanleadtofinancialdistressandbankruptcyEquityOwnershipinterestCommonstockholdersvotefortheboardofdirectorsandotherissuesDividendsarenotconsideredacostofdoingbusinessandarenottaxdeductibleDividendsarenotaliabilityofthefirm,andstockholdershavenolegalrecourseifdividendsarenotpaidAnallequityfirmcannotgobankruptmerelyduetodebtsinceithasnodebt7-21DifferencesBetween

DebtandTheBondIndentureContractbetweenthecompanyandthebondholdersthatincludesThebasictermsofthebondsThetotalamountofbondsissuedAdescriptionofpropertyusedassecurity,ifapplicableSinkingfundprovisionsCallprovisionsDetailsofprotectivecovenants7-22TheBondIndentureContractbetBondClassificationsRegisteredvs.BearerFormsSecurityCollateral–securedbyfinancialsecuritiesMortgage–securedbyrealproperty,normallylandorbuildingsDebentures–unsecuredNotes–unsecureddebtwithoriginalmaturitylessthan10yearsSeniority7-23BondClassificationsRegisteredBondCharacteristicsandRequiredReturnsThecouponratedependsontheriskcharacteristicsofthebondwhenissuedWhichbondswillhavethehighercoupon,allelseequal?SecureddebtversusadebentureSubordinateddebentureversusseniordebtAbondwithasinkingfundversusonewithoutAcallablebondversusanon-callablebond7-24BondCharacteristicsandRequiBondRatings–InvestmentQualityHighGradeMoody’sAaaandS&PAAA–capacitytopayisextremelystrongMoody’sAaandS&PAA–capacitytopayisverystrongMediumGradeMoody’sAandS&PA–capacitytopayisstrong,butmoresusceptibletochangesincircumstancesMoody’sBaaandS&PBBB–capacitytopayisadequate,adverseconditionswillhavemoreimpactonthefirm’sabilitytopay7-25BondRatings–InvestmentQualBondRatings-SpeculativeLowGradeMoody’sBaandBS&PBBandBConsideredpossiblethatthecapacitytopaywilldegenerate.VeryLowGradeMoody’sC(andbelow)andS&PC(andbelow)incomebondswithnointerestbeingpaid,orindefaultwithprincipalandinterestinarrears7-26BondRatings-SpeculativeLowGovernmentBondsTreasurySecuritiesFederalgovernmentdebtT-bills–purediscountbondswithoriginalmaturityofoneyearorlessT-notes–coupondebtwithoriginalmaturitybetweenoneandtenyearsT-bonds–coupondebtwithoriginalmaturitygreaterthantenyearsMunicipalSecuritiesDebtofstateandlocalgovernmentsVaryingdegreesofdefaultrisk,ratedsimilartocorporatedebtInterestreceivedistax-exemptatthefederallevel7-27GovernmentBondsTreasurySecurExample7.4Ataxablebondhasayieldof8%,andamunicipalbondhasayieldof6%.Ifyouareina40%taxbracket,whichbonddoyouprefer?8%(1-.4)=4.8%Theafter-taxreturnonthecorporatebondis4.8%,comparedtoa6%returnonthemunicipalAtwhattaxratewouldyoubeindifferentbetweenthetwobonds?8%(1–T)=6%T=25%7-28Example7.4AtaxablebondhasZeroCouponBondsMakenoperiodicinterestpayments(couponrate=0%)Theentireyield-to-maturitycomesfromthedifferencebetweenthepurchasepriceandtheparvalueCannotsellformorethanparvalueSometimescalledzeroes,deepdiscountbonds,ororiginalissuediscountbonds(OIDs)TreasuryBillsandprincipal-onlyTreasurystripsaregoodexamplesofzeroes7-29ZeroCouponBondsMakenoperioFloating-RateBondsCouponratefloatsdependingonsomeindexvalueExamples–adjustableratemortgagesandinflation-linkedTreasuriesThereislesspriceriskwithfloatingratebondsThecouponfloats,soitislesslikelytodiffersubstantiallyfromtheyield-to-maturityCouponsmayhavea“collar”–theratecannotgoaboveaspecified“ceiling”orbelowaspecified“floor”7-30Floating-RateBondsCouponrateOtherBondTypesDisasterbondsIncomebondsConvertiblebondsPutbondsTherearemanyothertypesofprovisionsthatcanbeaddedtoabondandmanybondshaveseveralprovisions–itisimportanttorecognizehowtheseprovisionsaffectrequiredreturns7-31OtherBondTypesDisasterbondsSukukSukukarebondshavebeencreatedtomeetademandforassetsthatcomplywithShariah,orIslamiclawShariahdoesnotpermitthechargingorpayingofinterestSukukaretypicallyboughtandheldtomaturity,andareextremelyilliquid7-32SukukSukukarebondshavebeenBondMarketsPrimarilyover-the-countertransactionswithdealersconnectedelectronicallyExtremelylargenumberofbondissues,butgenerallylowdailyvolumeinsingleissuesMakesgettingup-to-datepricesdifficult,particularlyonsmallcompanyormunicipalissuesTreasurysecuritiesareanexception7-33BondMarketsPrimarilyover-theWorktheWebExampleBondquotesareavailableonlineOnegoodsiteisFINRA’sMarketDataCenterClickonthewebsurfertogotothesiteChooseacompany,enteritinthesearchbar,chooseBondinthedrop-down,andseewhatyoucanfind!7-34WorktheWebExampleBondquoteTreasuryQuotationsHighlightedquoteinFigure7.415Nov247.5137.29137.313.9133Whatisthecouponrateonthebond?Whendoesthebondmature?Whatisthebidprice?Whatdoesthismean?Whatistheaskprice?Whatdoesthismean?Howmuchdidthepricechangefromthepreviousday?Whatistheyieldbasedontheaskprice?7-35TreasuryQuotationsHighlightedCleanvs.DirtyPricesCleanprice:quotedpriceDirtyprice:priceactuallypaid=quotedpriceplusaccruedinterestExample:ConsideraT-bondwitha4%semiannualyieldandacleanpriceof$1,282.50:Numberofdayssincelastcoupon=61Numberofdaysinthecouponperiod=184Accruedinterest=(61/184)(.04*1000)=$13.26Dirtyprice=$1,282.50+$13.26=$1,295.76So,youwouldactuallypay$1,295.76forthebond7-36Cleanvs.DirtyPricesCleanprInflationandInterestRatesRealrateofinterest–changeinpurchasingpowerNominalrateofinterest–quotedrateofinterest,changeinactualnumberofdollarsTheexantenominalrateofinterestincludesourdesiredrealrateofreturnplusanadjustmentforexpectedinflation7-37InflationandInterestRatesReTheFisherEffectTheFisherEffectdefinestherelationshipbetweenrealrates,nominalrates,andinflation(1+R)=(1+r)(1+h),whereR=nominalrater=realrateh=expectedinflationrateApproximationR=r+h7-38TheFisherEffectTheFisherEfExample7.5Ifwerequirea10%realreturnandweexpectinflationtobe8%,whatisthenominalrate?R=(1.1)(1.08)–1=.188=18.8%Approximation:R=10%+8%=18%Becausetherealreturnandexpectedinflationarerelativelyhigh,thereissignificantdifferencebetweentheactualFisherEffectandtheapproximation.7-39Example7.5Ifwerequirea10%TermStructureof

InterestRatesTermstructureistherelationshipbetweentimetomaturityandyields,allelseequalItisimportanttorecognizethatwepullouttheeffectofdefaultrisk,differentcoupons,etc.Yieldcurve–graphicalrepresentationofthetermstructureNormal–upward-sloping;long-termyieldsarehigherthanshort-termyieldsInverted–downward-sloping;long-termyieldsarelowerthanshort-termyields7-40TermStructureof

InterestRaFigure7.6–Upward-SlopingYieldCurve7-41Figure7.6–Upward-SlopingYiFigure7.6–Downward-SlopingYieldCurve7-42Figure7.6–Downward-SlopingFigure7.7InsertnewFigure7.7here7-43Figure7.7InsertnewFigure7.FactorsAffecting

BondYieldsRealrateofinterestExpectedfutureinflationpremiumInterestrateriskpremiumDefaultriskpremiumTaxabilitypremiumLiquiditypremium7-44FactorsAffecting

BondYieldsQuickQuizHowdoyoufindthevalueofabond,andwhydobondpriceschange?Whatisabondindenture,andwhataresomeoftheimportantfeatures?Whatarebondratings,andwhyaretheyimportant?Howdoesinflationaffectinterestrates?Whatisthetermstructureofinterestrates?Whatfactorsdeterminetherequiredreturnonbonds?7-45QuickQuizHowdoyoufindtheEthicsIssuesIn1996,allegationsweremadeagainstMoody’sthatitwasissuingratingsonbondsithadnotbeenhiredtorate,inordertopressureissuerstopayfortheirservice.Thegovernmentconductedaninquiry,butchargesofantitrustviolationsweredropped.Eventhoughnolegalactionwastaken,doesanethicalissueexist?7-46EthicsIssuesIn1996,allegatiComprehensiveProblemWhatisthepriceofa$1,000parvaluebondwitha6%couponratepaidsemiannually,ifthebondispricedtoyield5%andithas9yearstomaturity?Whatwouldbethepriceofthebondiftheyieldroseto7%.WhatisthecurrentyieldonthebondiftheYTMis7%?7-47ComprehensiveProblemWhatistEndofChapter7-48EndofChapter7-48

Chapter7 InterestRatesandBondValuationMcGraw-Hill/IrwinCopyright©2013byTheMcGraw-HillCompanies,Inc.Allrightsreserved. Chapter7McGraw-Hill/IrwinCopKeyConceptsandSkillsKnowtheimportantbondfeaturesandbondtypesUnderstandbondvaluesandwhytheyfluctuateUnderstandbondratingsandwhattheymeanUnderstandtheimpactofinflationoninterestratesUnderstandthetermstructureofinterestratesandthedeterminantsofbondyields7-50KeyConceptsandSkillsKnowthChapterOutlineBondsandBondValuationMoreaboutBondFeaturesBondRatingsSomeDifferentTypesofBondsBondMarketsInflationandInterestRatesDeterminantsofBondYields7-51ChapterOutlineBondsandBondBondDefinitionsBondParvalue(facevalue)CouponrateCouponpaymentMaturitydateYieldorYieldtomaturity7-52BondDefinitionsBond7-4PresentValueofCashFlows

asRatesChangeBondValue=PVofcoupons+PVofparBondValue=PVofannuity+PVoflumpsumAsinterestratesincrease,presentvaluesdecreaseSo,asinterestratesincrease,bondpricesdecreaseandviceversa7-53PresentValueofCashFlows

aValuingaDiscountBondwithAnnualCouponsConsiderabondwithacouponrateof10%andannualcoupons.Theparvalueis$1,000,andthebondhas5yearstomaturity.Theyieldtomaturityis11%.Whatisthevalueofthebond?Usingtheformula:B=PVofannuity+PVoflumpsumB=100[1–1/(1.11)5]/.11+1,000/(1.11)5B=369.59+593.45=963.04Usingthecalculator:N=5;I/Y=11;PMT=100;FV=1,000CPTPV=-963.047-54ValuingaDiscountBondwithAValuingaPremiumBondwithAnnualCouponsSupposeyouarereviewingabondthathasa10%annualcouponandafacevalueof$1000.Thereare20yearstomaturity,andtheyieldtomaturityis8%.Whatisthepriceofthisbond?Usingtheformula:B=PVofannuity+PVoflumpsumB=100[1–1/(1.08)20]/.08+1000/(1.08)20B=981.81+214.55=1196.36Usingthecalculator:N=20;I/Y=8;PMT=100;FV=1000CPTPV=-1,196.367-55ValuingaPremiumBondwithAnGraphicalRelationshipBetweenPriceandYield-to-maturity(YTM)BondPriceYield-to-maturity(YTM)7-56GraphicalRelationshipBetweenBondPrices:RelationshipBetweenCouponandYieldIfYTM=couponrate,thenparvalue=bondpriceIfYTM>couponrate,thenparvalue>bondpriceWhy?ThediscountprovidesyieldabovecouponratePricebelowparvalue,calledadiscountbondIfYTM<couponrate,thenparvalue<bondpriceWhy?HighercouponratecausesvalueaboveparPriceaboveparvalue,calledapremiumbond7-57BondPrices:RelationshipBetwTheBondPricingEquation7-58TheBondPricingEquation7-10Example7.1FindpresentvaluesbasedonthepaymentperiodHowmanycouponpaymentsarethere?Whatisthesemiannualcouponpayment?Whatisthesemiannualyield?B=70[1–1/(1.08)14]/.08+1,000/(1.08)14=917.56OrPMT=70;N=14;I/Y=8;FV=1,000;CPTPV=-917.567-59Example7.1FindpresentvaluesInterestRateRiskPriceRiskChangeinpriceduetochangesininterestratesLong-termbondshavemorepriceriskthanshort-termbondsLowcouponratebondshavemorepriceriskthanhighcouponratebondsReinvestmentRateRiskUncertaintyconcerningratesatwhichcashflowscanbereinvestedShort-termbondshavemorereinvestmentrateriskthanlong-termbondsHighcouponratebondshavemorereinvestmentrateriskthanlowcouponratebonds7-60InterestRateRiskPriceRisk7-Figure7.27-61Figure7.27-13ComputingYieldtoMaturityYieldtoMaturity(YTM)istherateimpliedbythecurrentbondpriceFindingtheYTMrequirestrialanderrorifyoudonothaveafinancialcalculatorandissimilartotheprocessforfindingrwithanannuityIfyouhaveafinancialcalculator,enterN,PV,PMT,andFV,rememberingthesignconvention(PMTandFVneedtohavethesamesign,PVtheoppositesign)7-62ComputingYieldtoMaturityYieYTMwithAnnualCouponsConsiderabondwitha10%annualcouponrate,15yearstomaturityandaparvalueof$1,000.Thecurrentpriceis$928.09.Willtheyieldbemoreorlessthan10%?N=15;PV=-928.09;FV=1,000;PMT=100CPTI/Y=11%7-63YTMwithAnnualCouponsConsideYTMwithSemiannualCouponsSupposeabondwitha10%couponrateandsemiannualcoupons,hasafacevalueof$1,000,20yearstomaturityandissellingfor$1,197.93.IstheYTMmoreorlessthan10%?Whatisthesemiannualcouponpayment?Howmanyperiodsarethere?N=40;PV=-1,197.93;PMT=50;FV=1,000;CPTI/Y=4%(IsthistheYTM?)YTM=4%*2=8%7-64YTMwithSemiannualCouponsSupTable7.17-65Table7.17-17CurrentYieldvs.YieldtoMaturityCurrentYield=annualcoupon/priceYieldtomaturity=currentyield+capitalgainsyieldExample:10%couponbond,withsemiannualcoupons,facevalueof1,000,20yearstomaturity,$1,197.93priceCurrentyield=100/1,197.93=.0835=8.35%Priceinoneyear,assumingnochangeinYTM=1,193.68Capitalgainyield=(1,193.68–1,197.93)/1,197.93=-.0035=-.35%YTM=8.35-.35=8%,whichisthesameYTMcomputedearlier7-66CurrentYieldvs.YieldtoMatBondPricingTheoremsBondsofsimilarrisk(andmaturity)willbepricedtoyieldaboutthesamereturn,regardlessofthecouponrateIfyouknowthepriceofonebond,youcanestimateitsYTMandusethattofindthepriceofthesecondbondThisisausefulconceptthatcanbetransferredtovaluingassetsotherthanbonds7-67BondPricingTheoremsBondsofBondPriceswithaSpreadsheetThereisaspecificformulaforfindingbondpricesonaspreadsheetPRICE(Settlement,Maturity,Rate,Yld,Redemption,Frequency,Basis)YIELD(Settlement,Maturity,Rate,Pr,Redemption,Frequency,Basis)SettlementandmaturityneedtobeactualdatesTheredemptionandPrneedtobeinputas%ofparvalueClickontheExceliconforanexample7-68BondPriceswithaSpreadsheetDifferencesBetween

DebtandEquityDebtNotanownershipinterestCreditorsdonothavevotingrightsInterestisconsideredacostofdoingbusinessandistaxdeductibleCreditorshavelegalrecourseifinterestorprincipalpaymentsaremissedExcessdebtcanleadtofinancialdistressandbankruptcyEquityOwnershipinterestCommonstockholdersvotefortheboardofdirectorsandotherissuesDividendsarenotconsideredacostofdoingbusinessandarenottaxdeductibleDividendsarenotaliabilityofthefirm,andstockholdershavenolegalrecourseifdividendsarenotpaidAnallequityfirmcannotgobankruptmerelyduetodebtsinceithasnodebt7-69DifferencesBetween

DebtandTheBondIndentureContractbetweenthecompanyandthebondholdersthatincludesThebasictermsofthebondsThetotalamountofbondsissuedAdescriptionofpropertyusedassecurity,ifapplicableSinkingfundprovisionsCallprovisionsDetailsofprotectivecovenants7-70TheBondIndentureContractbetBondClassificationsRegisteredvs.BearerFormsSecurityCollateral–securedbyfinancialsecuritiesMortgage–securedbyrealproperty,normallylandorbuildingsDebentures–unsecuredNotes–unsecureddebtwithoriginalmaturitylessthan10yearsSeniority7-71BondClassificationsRegisteredBondCharacteristicsandRequiredReturnsThecouponratedependsontheriskcharacteristicsofthebondwhenissuedWhichbondswillhavethehighercoupon,allelseequal?SecureddebtversusadebentureSubordinateddebentureversusseniordebtAbondwithasinkingfundversusonewithoutAcallablebondversusanon-callablebond7-72BondCharacteristicsandRequiBondRatings–InvestmentQualityHighGradeMoody’sAaaandS&PAAA–capacitytopayisextremelystrongMoody’sAaandS&PAA–capacitytopayisverystrongMediumGradeMoody’sAandS&PA–capacitytopayisstrong,butmoresusceptibletochangesincircumstancesMoody’sBaaandS&PBBB–capacitytopayisadequate,adverseconditionswillhavemoreimpactonthefirm’sabilitytopay7-73BondRatings–InvestmentQualBondRatings-SpeculativeLowGradeMoody’sBaandBS&PBBandBConsideredpossiblethatthecapacitytopaywilldegenerate.VeryLowGradeMoody’sC(andbelow)andS&PC(andbelow)incomebondswithnointerestbeingpaid,orindefaultwithprincipalandinterestinarrears7-74BondRatings-SpeculativeLowGovernmentBondsTreasurySecuritiesFederalgovernmentdebtT-bills–purediscountbondswithoriginalmaturityofoneyearorlessT-notes–coupondebtwithoriginalmaturitybetweenoneandtenyearsT-bonds–coupondebtwithoriginalmaturitygreaterthantenyearsMunicipalSecuritiesDebtofstateandlocalgovernmentsVaryingdegreesofdefaultrisk,ratedsimilartocorporatedebtInterestreceivedistax-exemptatthefederallevel7-75GovernmentBondsTreasurySecurExample7.4Ataxablebondhasayieldof8%,andamunicipalbondhasayieldof6%.Ifyouareina40%taxbracket,whichbonddoyouprefer?8%(1-.4)=4.8%Theafter-taxreturnonthecorporatebondis4.8%,comparedtoa6%returnonthemunicipalAtwhattaxratewouldyoubeindifferentbetweenthetwobonds?8%(1–T)=6%T=25%7-76Example7.4AtaxablebondhasZeroCouponBondsMakenoperiodicinterestpayments(couponrate=0%)Theentireyield-to-maturitycomesfromthedifferencebetweenthepurchasepriceandtheparvalueCannotsellformorethanparvalueSometimescalledzeroes,deepdiscountbonds,ororiginalissuediscountbonds(OIDs)TreasuryBillsandprincipal-onlyTreasurystripsaregoodexamplesofzeroes7-77ZeroCouponBondsMakenoperioFloating-RateBondsCouponratefloatsdependingonsomeindexvalueExamples–adjustableratemortgagesandinflation-linkedTreasuriesThereislesspriceriskwithfloatingratebondsThecouponfloats,soitislesslikelytodiffersubstantiallyfromtheyield-to-maturityCouponsmayhavea“collar”–theratecannotgoaboveaspecified“ceiling”orbelowaspecified“floor”7-78Floating-RateBondsCouponrateOtherBondTypesDisasterbondsIncomebondsConvertiblebondsPutbondsTherearemanyothertypesofprovisionsthatcanbeaddedtoabondandmanybondshaveseveralprovisions–itisimportanttorecognizehowtheseprovisionsaffectrequiredreturns7-79OtherBondTypesDisasterbondsSukukSukukarebondshavebeencreatedtomeetademandforassetsthatcomplywithShariah,orIslamiclawShariahdoesnotpermitthechargingorpayingofinterestSukukaretypicallyboughtandheldtomaturity,andareextremelyilliquid7-80SukukSukukarebondshavebeenBondMarketsPrimarilyover-the-countertransactionswithdealersconnectedelectronicallyExtremelylargenumberofbondissues,butgenerallylowdailyvolumeinsingleissuesMakesgettingup-to-datepricesdifficult,particularlyonsmallcompanyormunicipalissuesTreasurysecuritiesareanexception7-81BondMarketsPrimarilyover-theWorktheWebExampleBondquotesareavailableonlineOnegoodsiteisFINRA’sMarketDataCenterClickonthewebsurfertogotothesiteChooseacompany,enteritinthesearchbar,chooseBondinthedrop-down,andseewhatyoucanfind!7-82WorktheWebExampleBondquoteTreasuryQuotationsHighlightedquoteinFigure7.415Nov247.5137.29137.313.9133Whatisthecouponrateonthebond?Whendoesthebondmature?Whatisthebidprice?Whatdoesthismean?Whatistheaskprice?Whatdoesthismean?Howmuchdidthepricechangefromthepreviousday?Whatistheyieldbasedontheaskprice?7-83TreasuryQuotationsHighlightedCleanvs.DirtyPricesCleanprice:quotedpriceDirt