Bonds, Bond Valuation, and Interest RatesCHAPTER 5© 2020 Cen

Bonds, Bond Valuation, and Interest Rates
CHAPTER 5
© 2020 Cengage Learning. All Rights Reserved. May not be
copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product
or service or otherwise on a password-protected website for
classroom use.
Topics in Chapter
Key features of bonds
Bond valuation
Measuring yield
Assessing risk
classroom use.
Determinants of Intrinsic Value: The Cost of Debt
classroom use.
Key Features of a Bond (1 of 2)
Par value: Face amount; paid at maturity. Assume $1,000.
Coupon interest rate: Stated interest rate. Multiply by par

value to get dollars of interest. Generally fixed.
classroom use.
Key Features of a Bond (2 of 2)
Maturity: Years until bond must be repaid. Declines.
Issue date: Date when bond was issued.
Default risk: Risk that issuer will not make interest or principal
payments.
classroom use.
Call Provision
Issuer can refund if rates decline. That helps the issuer but
hurts the investor.
Therefore, borrowers are willing to pay more, and lenders
require more, on callable bonds.
Most bonds have a deferred call and a declining call premium.
classroom use.
What’s a sinking fund?
Provision to pay off a loan over its life rather than all at
maturity.

Similar to amortization on a term loan.
Reduces risk to investor, shortens average maturity.
But not good for investors if rates decline after issuance.
classroom use.
Sinking funds are generally handled in 2 ways
Call x% at par per year for sinking
fund purposes.
Call if rd is below the coupon rate and bond sells at a premium.
Buy bonds on open market.
Use open market purchase if rd is above coupon rate and bond
sells at a discount.
classroom use.
Value of a 10-year, 10% coupon bond if rd = 10%
classroom use.
The bond consists of a 10-year, 10% annuity of $100/year plus a

$1,000 lump sum at t = 10:PV annuity= $614.46PV maturity
value= 385.54Value of bond= $1,000.00
classroom use.
What would happen if expected inflation rose by 3%, causing r
= 13%?
When rd rises, above the coupon rate, the bond’s value falls
below par, so it sells at a discount.
classroom use.
What would happen if inflation fell, and rd declined to 7%?
If coupon rate > rd, price rises above par, and bond sells at a
premium.
classroom use.
Bond Value ($) vs. Years remaining to Maturity
(1 of 2)
Suppose the bond was issued 20 years ago and now has 10 years

to maturity. What would happen to its value over time if the
required rate of return remained at 10%, or at 13%, or at 7%?
See next slide.
classroom use.
(2 of 2)
classroom use.
(2 of 3)
At maturity, the value of any bond must equal its par value.
The value of a premium bond would decrease to $1,000.
The value of a discount bond would increase to $1,000.
A par bond stays at $1,000 if rd remains constant.
classroom use.
What’s “yield to maturity”?
YTM is the rate of return earned on a bond held to maturity.
Also called “promised yield.”

It assumes the bond will not default.
classroom use.
YTM on a 10-year, 9% annual coupon, $1,000 par value bond
selling for $887
classroom use.
Find rd
classroom use.
If coupon rate < rd, bond sells at a discount.
If coupon rate = rd, bond sells at its par value.
If coupon rate > rd, bond sells at a premium.
If rd rises, price falls.
Price = par at maturity.

classroom use.
Find YTM if price were $1,134.20.
Sells at a premium.
Because coupon = 9% > rd = 7.08%,
bond’s value > par.
classroom use.
Definitions
classroom use.
9% coupon, 10-year bond, P = $887, and YTM = 10.91%

classroom use.
YTM = Current yield + Capital gains yield.
Could also find values in Years 1 and 2,
get difference, and divide by value in
Year 1. Same answer.
classroom use.
Semiannual Bonds
1. Multiply years by 2 to get periods = 2N.
2. Divide nominal rate by 2 to get periodic rate =
rd/2.
3. Divide annual INT by 2 to get PMT = INT/2.
classroom use.
Value of 10-year, 10% coupon, semiannual bond if rd = 13%.
classroom use.

Spreadsheet Functions for Bond Valuation
See Ch04 Mini Case.xls for details.
PRICE
YIELD
classroom use.
Callable Bonds and Yield to Call
A 10-year, 10% semiannual coupon,
$1,000 par value bond is selling for
$1,135.90 with an 8% yield to maturity.
It can be called after 5 years at $1,050.
classroom use.
Nominal Yield to Call (YTC)
classroom use.
If you bought bonds, would you be more likely to earn YTM or
YTC?
Coupon rate = 10% vs. YTC = rd = 7.53%. Could raise money

by selling new bonds which pay 7.53%.
Could thus replace bonds which pay $100/year with bonds that
pay only $75.30/year.
Investors should expect a call, hence YTC = 7.5%, not YTM =
8%.
classroom use.
In general, if a bond sells at a premium, then coupon > rd, so a
call is likely.
So, expect to earn:
YTC on premium bonds.
YTM on par & discount bonds.
classroom use.
rd = r* + IP + MRP + DRP + LP.
classroom use.
What is the real risk-free rate (r*)?

Rate that a hypothetical riskless security pays each moment if
zero inflation were expected.
r* changes over time depending on economic conditions.
r* can be approximated by rate on short-term Treasury
Inflation-Protected Securities (TIPS).
classroom use.
What is the nominal risk-free rate (rRF)?
The rate on a U.S. Treasury security
Short-term security: T-bill
Long-term security: T-bond
classroom use.
Estimating IP
Treasury Inflation-Protected Securities (TIPS) are indexed to
inflation.
The IP for a particular length maturity can be approximated as
the difference between the yield on a non-indexed Treasury
security of that maturity minus the yield on a TIPS of that
maturity.
classroom use.

Bond Spreads, the DRP, and the LP
A “bond spread” is often calculated as the difference between a
corporate bond’s yield and a Treasury security’s yield of the
same maturity. Therefore:
Spread = DRP + LP.
Bond’s of large, strong companies often have very small LPs.
Bond’s of small companies often have LPs as high as 2%.
classroom use.
Bond RatingsBond Ratings% defaulting within:S&P and Fitch
Moody’s 1 yr. 5 yrs.Investment grade
bonds:AAAAaa0.130.68AAAa0.000.00AA0.090.96BBBBaa0.07
1.72Junk bonds:BBBa0.626.35BB2.0611.68CCCCaa21.3635.38
classroom use.
Bond Ratings and Bond Spreads (October 2016)Long-term
BondsYield (%)Spread (%) 10-Year T-bond1.72
AAA2.210.49 AA 2.270.55 A 2.420.70 BBB3.461.74 BB
5.163.44 B 6.584.86 CCC8.376.65
use as permitted in a license distributed with a certain pr oduct
classroom use.

What factors affect default risk and bond ratings?
Financial ratios
Debt ratio
Coverage ratios, such as interest coverage ratio or EBITDA
coverage ratio
Profitability ratios
Current ratios
classroom use.
Bond Ratings Median Ratios (S&P)Return on capital Debt to
capitalAAA27.6%12.4%AA27.0%28.3%A17.5%37.5%BBB13.4
%42.5%BB11.3%53.7%B8.7%75.9%CCC3.2%113.5%
classroom use.
Other Factors that Affect Bond Ratings (1 of 2)
Provisions in the bond contract
Secured versus unsecured debt
Senior versus subordinated debt
Guarantee provisions
Sinking fund provisions
Debt maturity

classroom use.
Other Factors that Affect Bond Ratings (2 of 2)
Other factors
Earnings stability
Regulatory environment
Potential product liability
Accounting policies
classroom use.
Interest rate (or price) risk for 1-year and 10-year 10% bonds
Interest rate risk:
Rising rd causes bond prices to fall1-Year1-Year10-Year10-
YearrdPrice
ChangePriceChange5.0%$1,048$1,3864.8%38.6%10.0%$1,000$
1,0004.5%33.5%15.0%$957$749
classroom use.
Value

classroom use.
What is reinvestment rate risk? (1 of 2)
The risk that CFs will have to be reinvested in the future at
lower rates, reducing income.
Illustration: Suppose you just won $500,000 playing the
lottery. You’ll invest the money and live off the interest. You
buy a 1-year bond with a YTM of 10%.
classroom use.
What is reinvestment rate risk? (2 of 2)
Year 1 income = $50,000. At year-end get back $500,000 to
reinvest.
If rates fall to 3%, income will drop from $50,000 to $15,000.
Had you bought 30-year bonds, income would have remained
constant.
classroom use.
The Maturity Risk Premium
Long-term bonds: High interest rate risk, low reinvestment rate
risk.
Short-term bonds: Low interest rate risk, high reinvestment rate
risk.
Nothing is riskless!
Yields on longer term bonds usually are greater than on shorter
term bonds, so the MRP is more affected by interest rate risk

than by reinvestment rate risk.
classroom use.
Term Structure Yield Curve
Term structure of interest rates: the relationship between
interest rates (or yields) and maturities.
A graph of the term structure is called the yield curve.
classroom use.
Hypothetical Treasury Yield Curve
classroom use.
Bankruptcy (1 of 4)
Two main chapters of Federal Bankruptcy Act:
Chapter 11, Reorganization
Chapter 7, Liquidation
Typically, company wants Chapter 11, creditors may prefer
Chapter 7.

classroom use.
Bankruptcy (2 of 4)
If company can’t meet its obligations, it files under Chapter 11.
That stops creditors from foreclosing, taking assets, and
shutting down the business.
Company has 120 days to file a reorganization plan.
Court appoints a “trustee” to supervise reorganization.
Management usually stays in control.
classroom use.
Bankruptcy (3 of 4)
Company must demonstrate in its reorganization plan that it is
“worth more alive than dead.”
Otherwise, judge will order liquidation under Chapter 7.
classroom use.
If the company is liquidated, here’s the payment priority:
Past due property taxes
Secured creditors from sales of secured assets.
Trustee’s costs
Expenses incurred after bankruptc y filing
Wages and unpaid benefit contributions, subject to limits

Unsecured customer deposits, subject to limits
Taxes
Unfunded pension liabilities
Unsecured creditors
Preferred stock
Common stock
classroom use.
Bankruptcy (4 of 4)
In a liquidation, unsecured creditors generally get zero. This
makes them more willing to participate in reorganization even
though their claims are greatly scaled back.
Various groups of creditors vote on the reorganization plan. If
both the majority of the creditors and the judge approve,
company “emerges” from bankruptcy with lower debts, reduced
interest charges, and a chance for success.
classroom use.
(
)
(
)
(
)
B

1NN
ddd
$100$100$1,000
V...
1r1r1r
$90.91...$38.55$385.54
$1,000.
=+++
+++
=+++
=
(
)
(
)
(
)
(
)
(
)
(
)
B
1NN
ddd
1NN
ddd
INTINTM
V...
1r1r1r
90901,000
887...
1r1r1r
=+++
+++

=+++
+++
Annual coupon pmt
Current yield
Current price
Change in price
Capital gains yield
Beginning price
Exp totalreturn= YTM ExpCurr yldExp cap
gains yld
=
=
=+
$90
Current yield
$887
0.101510.15%.
=
==
Cap gains yieldYTMCurrent yield
10.91%10.15%
0.76%.
=-
=-
=
Here:
rd Required rate of return on a debt se
curity.
r* Real riskfree rate.
IP Inflation premium.
MRP Maturity risk premium.
DRP Default risk premium.
LP Liquidity premium.
=
=-
=

=
=
=
1
3
Annotated Bibliography for Potential Title of Your Paper
Your Name
Methodist College
Course Number: Course Title
Instructor
Due Date
Annotated Bibliography for Potential Title of Your Paper
Fitzpatrick, J. (2016). Helping nursing students develop and
expand their emotional intelligence. Nursing Education
Perspectives 37(3), 124.

https://doi.org/10.1097/01.NEP.0000000000000020
Fitzpatrick discusses the need for nurses to have emotional
intelligence (EI). This assertion is backed by evidence from
previous studies. Fitzpatrick’s study focuses on the way in
which nursing students’ emotional intelligence can be
developed through reflective writing. The study was conducted
at multiple nursing colleges using objective data from EI test
scores. Joyce J. Fitzpatrick, PhD, MBA, RN, FAAN, is a
reputable scholar in her field as she is the Elizabeth Brooks
Ford Professor of Nursing, Frances Payne Bolton School of
Nursing, Case Western Reserve University. Additionally, the
journal is peer-reviewed, so the source is sound. Fitzpatrick
does not present any observable bias in her study. Through
results of the study, Fitzpatrick reveals that nursing students’ EI
can be improved through her prescribed methodology for guided
reflection. This source is applicable and valuable to my
research, as it reinforces the need for EI and the benefits of
reflective writing.
Gustin, L. W. and Wagner, L. (2012). The butterfly effect of
caring: Clinical nursing teachers’ understanding of self-
compassion as a source to compassionate care. Scandinavian
Journal of Caring Sciences 27(1), 175-183.
https://doi.org/10.1111/j.1471-6712.2012.01033.x
Gustin and Wagner present the “butterfly effect” of how nursing
students learning self-compassion translates to them giving
more compassionate care to their patients. Their study is
qualitative and does not appear to contain any bias. Lena
Wiklund Gustin PhD, RN is an Associate Professor of the
School of Health, Care, and Social Welfare at Mälardalen
University, and Lynne Wagner EdD, MSN, RN is a Nurse
Consultant and Nurse Educator at Watson Caring Science
Institute. Additionally, the publication is a peer-reviewed
journal; therefore, the source is sound. This source is very
relevant to my research because the main focus of my paper is
the need for nurses to have an ethic of self-care in order to be
effective health care providers.

Name: Olubunmi Salako
Date: 1/26/2021
Identification of Scenario & Proposal for Integration of
Coursework
Identify the leadership scenario you have chosen for the
assignment: Scenario #3: Patient Education & Services
Integration of Coursework
For this assignment, you are to integrate knowledge, content,
and/or skills learned in your non-clinical nursing and general
education courses. You must use two non-clinical nursing
courses, with at least one being an upper-division course. You
must also use two general education courses, with at least one
being an upper division course. (Note, if any of the courses
were not taken at Methodist College, you will need to provide a
syllabus for the that course with this assignment.) You will use
the knowledge, content, and/or skills from your chosen courses
to help you make an argument for the benefits of a BSN for a
nurse leaders and to help you devise and carry out a solution to
the problem in the scenario.
1. Non-Clinical Nursing Course
Course number & title:N211: Standards of Nursing Practice
Course content to be used: I intend to use the nursing ethical
principles of totality and integrity and the principle of
beneficence in my scenario analysis. I will use these principles
to justify to the charge nurse why it is essential to show
compassion and consider J.B's needs and concerns when
offering medication, education, and therapies. Also, I will use
these principles when preparing my plan of action.
2. Non-Clinical Nursing Course
Course number & title: N431: Health Policy
Course content to be used: In this course, I learned key

healthcare components such as organization and financing of
patient care services. I also learned how reimbursements are
structured. I plan to use this knowledge to identify health issues
affecting J.B and advocate for appropriate healthcare policies to
advance his needs. Also, I will strive to determine processes
that can be influenced by advocacy groups, healthcare
professionals, and governments to help J.B and patients with
similar concerns. I will also use the knowledge acquired during
this coursework to explore how J.B's socio-cultural practices,
legal, political, and economic factors impact healthcare
delivery, and practice. I will participate in political processes as
well as grassroots legislative initiatives to influence healthcare
policy that provides the needs of aged patients such as J.B.
Most importantly; I will take into account the impacts of
healthcare policies on various issues such as access, equity,
social justice, as well as affordability in healthcare delivery
when developing my plan of action.
3. General Education Course
Course number & title: HS 200: Introduc tion to Informatics for
Healthcare Professionals
Course content to be used: In HS 200, I learned about lower -
level informatics concerning computer applications and
healthcare information systems. In particular, I learned about
general computer information, healthcare specialty applications,
and healthcare information systems. I plan to use my knowledge
of healthcare informatics to enhance J.B's privacy and
confidentiality while at the same time ensuring ethical use of
electronic and digital channels of communication.
Understanding healthcare informatics components and concepts
will help me evaluate social, legal, and political factors
affecting patient-centered care to J.B and old patients.
Moreover, I will use the knowledge acquired during this course
work for civil engagement, conduct inquiries and analyses, and
engage J.B and patients from different cultural backgrounds. I
can apply health informatics' evidence-based practices,
especially in leadership and management, to develop my action

plan.
4. General Education Course
Course number & title: PH 300: Epidemiology
Course content to be used: In PH 300, I acquired essential
knowledge about the scope of practice and scientific methods
involved in the study of epidemiology. Specifically, I learned
how to apply epidemiologic methods to clinical sciences and
use findings from investigations and analyses for policy
generation. I plan to use this information to inquiry and analyze
the source of J.B's feeling of loneliness and other concerns. I
will assess various alternatives to solve J.B's problems through
quantitative reasoning and deductive and inductive reasoning.
In essence, I will use the knowledge acquired during this course
to understand patterns and causations of J.B's disease.
Moreover, I will assess social and behavioral epidemiology and
unique applications.
ANNOTATED BIBLIOGRAPHY 2
Specifications for Annotated Bibliography
Your annotated bibliography (20 points) must have eight
entries, one for each source. Each entry is worth 2.5 points and
needs to include:
· Reference entry (must be in proper APA format) (.5 points
per entry)
· Annotation which includes:
· Summary of source content & overview of argument (.5 points
per entry)
· Evaluation of content: bias & objectivity (.5 points per entry)
· Evaluation of source: author(s) & publication (.5 points per
entry)
· Relevance to your paper topic (.5 points per entry)
Color-Coded Examples
Fitzpatrick, J. (2016). Helping nursing students develop and

expand their emotional intelligence. Nursing Education
Perspectives 37(3), 124.
doi:10.1097/01.NEP.0000000000000020
Fitzpatrick discusses the need for nurses to have emotional
intelligence (EI). This assertion is backed by evidence from
previous studies. Fitzpatrick’s study focuses on the way in
which nursing students’ emotional intelligence can be
developed through reflective writing. The study was conducted
at multiple nursing colleges using objective data from EI test
scores. Joyce J. Fitzpatrick, PhD, MBA, RN, FAAN, is a
reputable scholar in her field as she is the Elizabeth Brooks
Ford Professor of Nursing, Frances Payne Bolton School of
Nursing, Case Western Reserve University. Additionally, the
journal is peer-reviewed, so the source is sound. Fitzpatrick
does not present any observable bias in her study. Through
results of the study, Fitzpatrick reveals that nursing students’ EI
can be improved through her prescribed methodology for guided
reflection. This source is applicable and valuable to my
research, as it reinforces the need for EI and the benefi ts of
reflective writing.
Gustin, L. W. and Wagner, L. (2012). The butterfly effect of
caring: Clinical nursing teachers’ understanding of self-
compassion as a source to compassionate care. Scandinavian
Journal of Caring Sciences 27(1), 175-183. doi:10.1111/j.1471-
6712.2012.01033.x
Gustin and Wagner present the “butterfly effect” of how nursing
students learning self-compassion translates to them giving
more compassionate care to their patients. Their study is
qualitative and does not appear to contain any bias. Lena
Wiklund Gustin PhD, RN is an Associate Professor of the
School of Health, Care, and Social Welfare at Mälardalen
University, and Lynne Wagner EdD, MSN, RN is a Nurse
Consultant and Nurse Educator at Watson Caring Science
Institute. Additionally, the publication is a peer-reviewed
journal; therefore, the source is sound. This source is very
relevant to my research because the main focus of my paper is

the need for nurses to have an ethic of self-care in order to be
effective health care providers.
Annotated Bibliography
An annotated bibliography provides specific information about
each source you have used. As a researcher, you have become
an expert on your topic: you have the ability to explain the
content of your sources, assess their usefulness, and share this
information with others who may be less familiar with them.
Think of your paper as part of a conversation with people
interested in the same things you are; the annotated
bibliography allows you to tell readers what to check out, what
might be worth checking out in some situations, and what might
not be worth spending the time on. It is kind of like providing a
list of good movies for your classmates to watch and then going
over the list with them, telling them why this movie is better
than that one or why one student in your class might like a
particular movie better than another student would. You want to
give your audience enough information to understand basically
what the movies are about and to make an informed decision
about where to spend their money based on their interests.
What does an annotated bibliography do?
A good annotated bibliography:
· encourages you to think critically about the content of the
works you are using, their place within a field of study, and
their relation to your own research and ideas
· proves you have read and understand your sources
· establishes your work as a valid source and you as a
competent researcher
· situates your study and topic in a continuing professional
conversation
· provides a way for others to decide whether a source will be
helpful to their research if they read it
· could help interested researchers determine whether they are

interested in a topic by providing background information and
an idea of the kind of work going on in a field
APA
APA does not have an official format for annotated
bibliographies. Methodist College has established the following
format:
· format the entire document as you would an APA paper, with a
title page, etc.
· format the bibliographic citation for each source as you would
a reference entry in APA format
· after the bibliographic citation, drop down to the next line to
begin the annotation, but do not skip an extra line
· indent the annotation one tab
· MC has created a template to aid you in the formatting of your
annotated bibliography
Critical & Evaluative Annotations
When creating a critical and evaluation annotation for a source,
you need to:
· sum up the content of the source, as a book report might
· give an overview of the arguments and proofs/evidence
addressed in the work and note the resulting conclusion
· evaluate the source or author critically (biases, lack of
evidence, objective, etc.)
· show how the work may or may not be useful for a particular
field of study or audience
· explain how researching this material assisted your own
project

Bonds, Bond Valuation, and Interest RatesCHAPTER 5© 2020 Cen

More Related Content

Similar to Bonds, Bond Valuation, and Interest RatesCHAPTER 5© 2020 Cen (20)

More from JeniceStuckeyoo (20)

Recently uploaded (20)

Bonds, Bond Valuation, and Interest RatesCHAPTER 5© 2020 Cen