FINANCE 42014250 note. Chapter 3 Bonds and Loanable Funds

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Bond: A written legal contract that is a promise to repay with interest; issued by a corporation, government or government agency. Coupon payment: Savers buy these bonds and, in most cases, get paid... interest in return —usually every six months. Coupon rate: The stated rate of interest that will be paid to the holder of the bond. Face value (of a bond): The original amount of money borrowed by a bond issuer. This is also sometimes called the bond principal. Secondary bond market: The market for bonds or other debt instruments that were previously issued. Rate of Return = Amount get back / Amount put in Market price of a bond: The present value of the cash flow the owner of the bond can expect to receive over the life of the bond. PBOND = PVBOND = C 1 (1+k)1 + C 2 (1+k)2 +…+ Cn+Face (1+k)n Par: Market price of a bond equals the face value of the bond. (when the market interest rate equals the bond’s coupon rate) Discount: When the market price is below the face value. (when the market interest rate above the bond’s coupon rate) below par Premium: When the market price of a bond is above the face value. (when the market interest rate below the bond’s coupon rate) above par Change in supply versus change in quantity supplied: Change in supply is a change in the price and quantity relationship from a seller’s perspective, whereas a change in quantity supplied comes about from a change in the price of the good or service. Change in demand versus change in quantity demanded: Change in demand is a change in the price and quantity relationship from a buyer’s perspective, whereas a change in quantity demanded comes about from a change in the price of the good or service.Primary market: The initial sale of a bond. As the price of bonds increases, or their yields decrease, these issuers will want to issue more bonds because the yield, or the interest rate the issuers have to pay to bondholders, the borrowing costs of bond issuers decline. Thus, in the primary market, as the bond prices increase, the quantity of bonds in demand increases; that is, the supply curve of bonds slopes upward. Secondary bond market: The market for bonds or other debt instruments preciously issued. As the price of bonds increases in the secondary market, we have an increase in the quantity supplied of bonds. The Supply for Bonds 1. Business Expectations If businesspeople become more optimistic about the future, they will want to borrow more money to expand their output. 2. Expected Inflation If you think there will be inflation in the future, you want to borrow more now.Inflation reduces the real cost of debt Real cost of debt: The burden of debt measured in constant terms. 3. Government Deficits 4. Investment Tax Credits To get this tax credit, imagine the consumer goods producer has to spend $60 million to expand its headquarters. So, to get the $5 million tax credit, Kimberly-Clark has to spend $60 million. Where will Kimberly-Clark get that $60 million? It will most likely issue bonds. The Demand for Bonds 1. Wealth 2. Expected Relative Returns to Bonds 3. Relative Riskiness of Bonds Default risk: The risk that a borrower will not pay interest or principal as promised. 4. Liquidity of Bonds Liquidity: The ease and expense at which one asset can be converted into another asset.5. Information Costs Equilibrium in the Bond Market (Surplus & Shortage) [Show More]

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