1. Chapter 9 Investing in Long-Term Debt (Bonds)

2. Characteristics of All Bonds Interest - coupon rate Principal amount Maturity date

3. Characteristics of All Bonds The indenture The trustee Yield –Current yield –Yield to maturity

4. Risk to Bondholders Default - failure to meet the terms of the indenture Fluctuations in interest rates Reinvestment rate risk Loss of purchasing power

5. Importance of Ratings Investment grade - triple B or better Non-investment grade (high-yield bonds) Moody’s and Standard & Poor’s ratings

6. Importance of Ratings Similarity of ratings Ratings do change

7. Types of Corporate Bonds Mortgage bonds Equipment trust certificates Debentures Subordinated debentures Income and revenue bonds

8. Types of Corporate Bonds Convertible bonds Variable interest rates bonds Zero coupon and discount bonds Eurobonds

9. High-yield (Junk) Bonds Non-investment grade Poor quality increases the yields over investment grade bonds

10. Bonds are Issued as Bearer bond Registered bond Book-entry bond

11. Price of a Bond The present value of the cash flows Interest and principal are discounted back to the present at the going rate of interest on comparable debt

12. Comparable Debt Same term to maturity Same risk class

13. Comparable Debt Comparable bonds –can have different coupons –can have different prices

14. Bond Pricing Price (PV) of a $1,000 bond that pays 6% interest and matures after 3 years Unknown: PV PMT = 60 FV = 1000 N = 3 I = 10 Answer: $1,000

15. Same Bond at a Discount Unknown: PV PMT = 100 FV = 1000 N = 3 I = 8 The discount is the result of interest rates rising Answer: $948.62

16. Same Bond at a Premium Unknown: PV PMT = 100 FV = 1000 N = 3 I = 4 The premium is the result of interest rates declining Answer: $1,055.56

17. Relationship The inverse relationship between –Bond prices and –Interest rates Interest rate risk –Higher rates cause bond prices to decline

18. Relationship Between Interest Rates and a Bond’s Price

19. The Current Yield Annual interest payment/Price of the bond Current flow of interest as a % $60/$948.62 = 6.3%

20. The Yield to Maturity The rate which equates 1.the present value of the cash inflows: the interest payment and principal repayment and 2.the cash outflow: the cost of the bond

21. Yield to Maturity Unknown: I PV = $952 PMT = $100 FV = 1000 N = 3 Answer: 12%

22. Current Yield and Yield to Maturity Current yield exceeds yield to maturity –if bond sells for a premium Yield to maturity exceeds the current yield –if the bond sells for a discount

23. Current Yield and Yield to Maturity The current yield does not consider the premium or discount The premium reduces the yield to maturity The discount increases the yield to maturity

24. Retiring Debt Bonds issued in a series Sinking funds Call feature Repurchases

25. Features of Convertible Bonds Convertible into common stock at the holder's option Interest (coupon) Maturity date Call feature

26. Convertible Bonds The three possible outcomes –conversion –retirement at maturity –default

27. Convertible Bonds Number of shares into which the bond may be converted Face value divided by the conversion price $1000 / $20 = 50 shares

28. Convertible Bonds Conversion Price –Face value dividend by the number of shares into which the bond may be converted –$1000 / 50 shares = $20

29. A Convertible Bond's Value as Stock The number of shares times the price of the stock 50 shares x $10 = $500

30. Relationship Between the price of a stock and the conversion value of the bond

31. Value of a Convertible Bond as Debt Model for the pricing of a bond applies Present value of the –Interest payment –Principal repayment

32. Value of a Convertible Bond as Debt

33. Minimum Price Minimum price of the bond combines –the value of the bond as stock and –the value as debt

34. Minimum Price

35. Actual Price of a Convertible Bond

36. The Premiums The premiums paid over –The bond's value as stock –The bond's value as debt

37. The Premiums

38. Importance of the Call Feature Company may call the bond Forced conversion Price of stock exceeds conversion price

39. Failure to Convert Lose price appreciation Receive face value

40. Convertible Preferred Stock The features associated with convertible bonds apply to convertible preferred stock Except –the instrument is equity –lacks the safety associated with debt

41. Federal Government Securities Nonmarketble federal government debt –Series EE (“patriot”) bond

42. Federal Government Securities Marketable federal government debt –Treasury bills –Treasury notes and bonds –Zero coupon bonds

43. Federal Debt Amount of federal debt in existence primarily consists of –Treasury bills –Intermediate - term debt –Bonds Emphasis on short-term debt

44. Federal Debt and Risk Safe from default Risk from price fluctuations Purchasing power risk

45. Municipal Bonds (State and Local Government Debt) The tax exemption –interest is exempt from federal income taxation The taxable equivalent equation: i c (1 - t) = i m

46. Risks Associated with Municipal Bonds Changes in interest rates Purchasing power risk Default