1. CHAPTER TWENTY-ONE
BOND ANALYSIS

2. 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

3. CAPITALIZATION OF INCOME METHOD
INTRINSIC VALUE
In equation form

4. 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

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

6. 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

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

8. 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

9. 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

10. MARKETABILITY MARKETABILITY
refers to the ability of the investor to resell

11. 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

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

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

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

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

16. 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