CHAPTER TWENTY-ONE BOND ANALYSIS

CAPITALIZATION OF INCOME METHOD PROMISED YIELD-TO-MATURITY In equation form where P=the current market price of bond n=the number of years to maturity Ct=the annual coupon payment y=the prevailing yield to maturity

CAPITALIZATION OF INCOME METHOD INTRINSIC VALUE In equation form

CAPITALIZATION OF INCOME METHOD SOLVING FOR V, Given the current market price (P), the investment decision is if V is the intrinsic value and V>P buy the bond V<P don’t buy

CAPITALIZATION OF INCOME METHOD ALTERNATIVELY SOLVING FOR y* y*>y bond overprice y*<y bond underpriced

BOND ATTRIBUTES SIX ATTRIBUTES that affect a bond’s value LENGTH OF TIME TO MATURITY COUPON RATE CALL PROVISIONS TAX STATUS MARKETABILITY LIKELIHOOD OF DEFAULT

LENGTH OF TIME TO MATURITY COUPON RATE AND LENGTH TO MATURITY these attributes determine size and timing of cash flow yield-to-maturity

TAX STRUCTURE TAX STRUCTURE Taxation affects bond prices and yields low-coupon bonds selling at a discount provide return in coupon payments gains from price appreciations taxes on appreciations may be deferred until bond sale or maturity discount bonds have a tax advantage

TAX STRUCTURE TAX STRUCTURE Taxation affects bond prices and yields because of tax effect, discount bonds should have a slightly lower before-tax yield low-coupon bonds will have a slightly higher intrinsic value

MARKETABILITY MARKETABILITY refers to the ability of the investor to resell

MARKETABILITY MARKETABILITY bid-ask spread is one indicator of marketability the higher the spread, the less marketable the lower the spread, the more marketable bonds that are actively traded should have a lower YTM and a higher V

MARKETABILITY MARKETABILITY bonds that are actively traded should have a lower YTM and a higher V

LIKELIHOOD OF DEFAULT LIKELILHOOD OF DEFAULT Bond ratings provided by professional services.

LIKELIHOOD OF DEFAULT LIKELILHOOD OF DEFAULT Two most famous include Moody’s Investors Services, Inc. Standard & Poor’s Corporate ratings

LIKELIHOOD OF DEFAULT LIKELIHOOD OF DEFAULT Categories investment grade usually the bonds in the top four ratings speculative often called junk bonds

LIKELIHOOD OF DEFAULT LIKELIHOOD OF DEFAULT Bond ratings provided by professional services. better ratings are generally associated with larger financial leverage larger firm size larger and steadier profits large cash flows lack of subordination to other debt series