Programa general de examen de cuentas a las cuentas previsionales previsionales

The bonds will have a maturity date of ten years from the date of issue and a face value of $1,000. The company will issue as many bonds as it needs for the equipment purchase – if the equipment costs $10,000,000 fully installed, then the company will issue 10,000 bonds.

Coupon rate 2. Investment bankers set the coupon rate for the bonds. The investment bankers attempt to gauge the interest rate environment and set the coupon rate commensurate with other bonds with similar risk and maturity. The coupon rate dictates whether the bonds will be sold in the secondary market at face value or at a discount or premium. If the coupon rate is higher than the prevailing interest rate, the bonds will sell at a premium; if the coupon rate is lower than the prevailing interest rate, the bonds will sell at a discount.

Primary issue 3. Investment bankers find investors for the bonds and issue them in the primary market.

The investment bankers use their system of brokers and dealers to find investors to buy the bonds. When investment bankers complete the sale of the bonds to investors, they turn over the proceeds of the sale (less the fees for performing their services) to the company to use for the purchase of equipment. The total face value of the bonds appears as a liability on the company's balance sheet.

Secondary market

4. The bonds become available in the secondary market.

Once the bonds are sold in the primary market to investors, they become available for purchase or sale in the secondary market. These transactions usually take place between two investors – one investor who owns bonds that are no longer needed for his/her investment portfolio and another investor who needs those same bonds.

Pricing Bonds

This section focuses on the calculations investors make to determine the price at which they will sell or buy bonds in the secondary markets.

Present value of cash flows

Pricing a bond involves finding the present value of the cash flows from the bond throughout its life. The formula for calculating the present value of a bond is:

V = C[1 / (1+R)]1 + C[1 / (1+R)]2 + ... + C[1 / (1+R)]T + F[1 / (1+R)]T Where:

V = Present value of the bond

C = Coupon payment (coupon rate multiplied by face value) R = Discount rate (current prevailing rate)

F = Face value of the bond

T = Number of compounding periods until maturity

Similar to

present value of an annuity

You may notice that this formula is similar to the formula for calculating the present value of an annuity. In fact, it is the same except the coupon payment (C) replaces the annuity payment (A). There is also one additional term, F[1/(1+R)]T, at the end of the

formula. This term represents the discounting of the face value amount that is received at the maturity of the bond. The formula can be

shortened to:

V = C x PVIFA(R,T) + F x PVIF(R,T)

Using this formula, we multiply the present value interest factor of an annuity by the coupon payment and add the product of the face value and the present value interest factor. Let's look at two examples to see how this formula works.

Example one: present value of bond

What is the present value of a bond with a two-year maturity date, a face value of $1,000, and a coupon rate of 6%? The current

prevailing rate for similar issues is 5%. To apply the formula, C = $60 ($1,000 x 0.06), R = 0.05, T = 2, and F = $1,000. V = C[1 / (1+R)]1 + C[1 / (1+R)]2 + F[1 / (1+R)]2 V = $60[1 / (1+0.05)] + $60[1 / (1+0.05)]2 _{+ $1,000[1 / (1+0.05)]}2 V = $60[0.95238] + $60[0.90703] + $1,000[0.90703] V = $57.14 + $54.42 + $907.03 V = $1,018.59

The present value of $1,018.59 is the price that the bond will trade for in the secondary bond market. You will notice that the price is higher than the face value of $1,000. In the time since these bonds were issued, interest rates have fallen from 6% to 5%. Investors are willing to pay more for the $60 interest payments when compared with new bond issues that are only paying $50 in interest per $1,000 face value. This inverse relationship is important.

As interest rates fall, bond prices rise; as interest rates rise, bond prices fall.

A bond with a coupon rate that is the same as the market rate sells for face value. A bond with a coupon rate that is higher than the prevailing interest rate sells at a premium to par value; a bond with a lower rate sells at a discount. Investment bankers attempt to set the coupon rate for a newly issued bond at the market interest rate so that the bond sale will yield the amount of capital their corporate clients need for operations.

Using the financial calculator

You can use a financial calculator to find the present value of the bond in the example. With most financial calculators you input the number of interest payments, the size of the payments, the face

value, and the discount rate. The present value key gives you the appropriate answer. Check your owner's manual for the specifics on how to calculate the present value of a bond.

Example two: present value of a bond

Let's look at one more example. If the current interest rate is 9%, how much would an investor be willing to pay for a $10,000 face value bond with 5 coupon payments of 7.5% left until maturity? Use these values in the formula: C = $750, R = 0.09, T = 5, and F = $10,000.

V = C[1 / (1+R)]1 _{+ C[1 / (1+R)]}2 _{+ ... + C[1 / (1+R)]}5 _{+ F[1 / (1+R)]}5

V = $750[1 / (1+0.09)]1 + $750[1 / (1+0.09)]2 _{+ ... + $750[1 / (1+0.09)]}5 ₊

$10,000[1/(1+0.09)]5

V = $750[0.91743] + $750[0.84168] + ... + $750[0.64993] + $10,000[0.64933] V = $9,416.55

As you can see, longer maturities require more calculations. Using your calculator's cash flow functions can save a lot of time.

In this section, we have discussed the pricing of one type of debt financing. You have seen that the present value of a bond is the price at which it will trade in the secondary market. Now, let's see how the market values equity financing.