Formulas of Accrued Interest in Exam 2 Cheat Sheet | FIN 310, Study notes of Financial Market

Download Formulas of Accrued Interest in Exam 2 Cheat Sheet | FIN 310 and more Study notes Financial Market in PDF only on Docsity! Formulas: 1) Accrued Interest a) 2) Clean Price of a Bond a) b) Vb: The present value of the bond c) M: The par value of the bond d) INT: Annual interest payments (in dollars) e) N: The number of years until the bond matures f) m: The number of times per year interest is paid g) id: interest rate used to discount cash flows on the bond 3) Dirty Price of a Bond a) Accrued Interest + Clean Price b) See ch6 quiz, problem 1 4) After Tax Return a) Corporate (Taxable Bond) i) ia = ib (1-t) b) Municipal Tax Equivalent Rate of Return i) ib = ia / (1-t) c) ia: After-Tax rate of return on a taxable corporate bond d) ib: Before-Tax rate of return on a taxable bond e) t: marginal total income tax rate of the bond f) See ch6 quiz, problem 2 5) Rate of Return on a Bond 6) Quoted Ask Yield on a Bond 7) Cumulative 8) Straight Line 9) Earnings Per Share just by looking at a stock quote a) Price / P/E Knowledge Based A. Sinking Fund Provision a. A requirement that the issuer retire a certain amount of the bond issue early as the bonds approach maturity b. Almost like a payment plan for bond issuers. A fund held by a trustee that the issuer pays into to either call or buy bonds before their maturity or to simply accumulate the cash to pay the bond issue off at maturity before the time comes. This reduces the probability of default at maturity and is attractive to bond holders, so bonds with a sinking fund provision are less risky and have lower yields than comparable bonds with no sinking fund provision B. Callable Bond Accrued interest = INT 2 × Actual number of days since last coupon payment Actual number of days in coupon period V b= INT m (PVIFA id/m,Nm )+M (PVIF id /m, Nm) a. Allows the issuer to require the bond holder to sell the bond back to the issuer at a given (call) price usually set above the par value of the bond b. Callable bonds can be bought back by the issuer per a call provision at a price above the face value. The difference between face value and call price is the call premium. The call premium declines in value as maturity date approached because it saves the issuer less money. Call options are executed when interest rates drop and issuers can borrow cheaper money. Call provisions are unattractive to investors because the duration is controlled by the issuer, so callable bonds have higher yields than comparable non-callable bonds. C. Required Rate of Return Based on Credit Quality a. The better credit quality a company has the lower the required rate of return will be b. Lower credit qualities require a higher rate of return, which means they have a lower PV than a security of the same FV and a lower risk/lower rate of return D. Investment Grade Bonds vs. Junk Bonds a. Investment Grade Bonds i. Bonds with a rating of BBB or higher ii. Lower interest rate iii. Lower Required Rate of Return b. Junk Bonds or High Yield Bonds(speculative-grade bonds) i. Bonds with a rating BB+ or lower ii. Higher interest rates iii. Higher Required Rate of Return E. Municipal Bonds a. Municipal bonds (Munis) i. Securities issued by state and local governments 1. To fund imbalances between expenditures and receipts 2. To finance long-term capital outlays ii. Attractive to household investors because interest is exempt from federal and most local income taxes b. General Obligation (GO) Bonds i. Backed by the full faith and credit of the issuing municipality c. Revenue Bonds i. Sold to finance specific revenue generating projects d. Collateral i. Tax-exempt bonds are used as collateral for indebtedness F. Stocks vs. Bonds a. Stocks i. Own part of a company ii. Have voting rights in the company iii. Limited Liability iv. Never expire v. Quote 1. Ticker Price b. Bonds