The most successful persons

are those who do not cheat

themselves to meet others
expectations.
CHAPTER 7
Long term debt instrument
Issued by corporations or government

Treasury bonds treasuries/government bonds (no DRP +
no LP)
Corporate bonds with credit risk (DRP)
Municipal bonds issued by state and local government
Foreign bonds issued by foreign government with DRP

Par value = Face value of the bond

Coupon payment = interest rate
Floating fluctuates based on general interest
Fixed
Zero coupon = 0% issued at discount or below par
Original issue discount bond = issued below par

Maturity date
Original maturity date maturity date when the
bond is first issued

Call Provisions = gives the issuer the right to
redeem the bonds

Sinking Funds = requires the issuer to retire a
portion of the bond issue each year.

Sinking fund occurs if interest goes down
after issuance of bond

Others:
Convertible option to issue common stock
Warrant option to buy shares of stock
Putable investors right to sell back
Income payment of interest depends on whether it is
earned
Indexed interest to be paid is based on inflation index

Convertible, warrant, putable and callable bonds have
high returns compared to plain bonds because these are
riskier bonds.
Therefore, if a plain bond is converted to these type of
bond, the coupon rate will have to be lower than that of
a plain bond.
If market interest rate = coupon rate, the
bond is issued at face.


If market interest rate is higher than coupon
rate, the bond is issued at discount.


If market interest rate is lower than coupon
rate, the bond is issued at premium.




Discount Bond face value is sold below par
value, occurs when the going rate is above
the coupon rate

Premium Bond face value is sold above par
value

Discount Bond face value is sold below par
value, occurs when the going rate is above
the coupon rate

Premium Bond face value is sold above par
value

Example:
A bond that matures in 8 years has a par
value of 1,000 and an annual coupon
payment of 70, its market interest rate is 9%



PV Factor Amount PV
Principal (0.50) 1,000 (501.87)
Interest (5.53) 70 (387.44)
(889.30)
Example:
A bond that matures in 12 years has a par
value of 1,000 and an annual coupon rate of
10%, its market interest rate is 8%



PVFactor Amount PV
Principal (Php0.40) 1,000 (397.11)
Interest (Php7.54) 100 (753.61)
(1,150.72)
Yield to maturity
Yield to call
EXAMPLE: Suppose a 20-year bond with face
value of P1,000 has a coupon rate of 7.5% per
annum. After one-year, the market interest
rate is of the bond is 5.5%.

What is the yield to maturity of this bond
given that there is 19 years up to the date of
maturity?
Answer:



Face Value PVF* YTM
Principal 1,000 0.361579 361.58
Interest
(1,000 x 7.5%) 75 11.3516 851.37
1,212.95
*Present Value Factor
Principal - 1/((1+0.055)^19)
Interest - Grandtotal of 1.055^-19

Price risk
Reinvestment risk


Comparing price risk and reinvestment risk:
Investment Horizon
Duration
LT bonds have less reinvestment risk



Mortgage bond
Indenture
Debenture
Subordinated debenture

Senior debt is less risky than subordinated
debt
Subordinated has higher return because it is
more risky.

Criteria:
Financial ratio
Qualitative bond contract terms
Miscellaneous sensitivity of earnings to
economy