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Bonds -- Basic Features PowerPoint Presentation
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Bonds -- Basic Features

Bonds -- Basic Features

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Bonds -- Basic Features

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  1. Bonds -- Basic Features • Contract: interest, par, maturity • Senior or Junior claim? • Collateral or Debenture • Sinking Fund • Call (or Put) feature • Conversion feature • Other types (floating rate,zero coupon)

  2. Bond Ratings • Assessment of creditworthiness • Issues rated not firms • Ratings agencies • Investment grade vs. Junk • Ratings changes and value

  3. Bond Ratings -- S&P Outline • Industry Analysis • Industry Risk • Market Position • Operating Efficiency • Management Evaluation • Financial Analysis • Earnings Protection • Financial leverage and asset protection • Cash flow adequacy • Financial flexibility • Accounting Quality

  4. Bond Valuation • Present value! • Assume cash flows known, adjust for risk in the required return (or YTM) • Examples • Bond Pricing Rules • YTM vs. Realized (or Effective) Yield

  5. Yield to Maturity • Interest rate that equates the PV of bond’s future payments with current price • Assumes: • Bond is held to maturity • All coupon and principal payments made in a timely manner • Coupons are reinvested at YTM • YTM is a “promised” yield

  6. Realized Yield • Rate of return actually received on investment at end of holding period • Can be interpreted as expected return if done ex-ante • To find RY: • Find FV of all coupon payments as of end of HP. Use proper reinvestment rate • Add FV to selling price (or par) of bond (TW) • Find compounded rate connecting orig. price with terminal value

  7. Convertible Bonds • “Vanilla” Bond plus option to convert to fixed number of shares of common • Conversion Ratio = # shares per bond • Conversion Price = Par/CR • Conversion Value = Share Price x CR • Conv. Bond Value = Pure Bond Value + Option Value

  8. Duration and Immunization • Price risk and Reinvestment rate risk • Duration is an index of a bond’s price sensitivity to interest rate fluctuations • Can be used to forecast interest rate driven price fluctuations for bonds or portfolios. • ==> Powerful risk management tool! • If Duration = Holding Period, you’re immunized from interest rate risk