PArT 2: VALUATION, rISk AND reTUrN
IMPOrTANT eQUATIONS
4.1 The fundamental valuation model =
++
++ ⋅⋅⋅⋅+
+PCF
rCF
rCF
(1 )(1) (1 r)n(^0) n
1
1
2
2
4.2 The basic equation =
- ⋅⋅⋅⋅+
P
C
r
C
r
C
r
M
(^0) (1 )( (^121) )( 1 )(nn 1 r)
4.2a =×−
P + +
C
rr
M
r
1
1
(^0) (1 )(nn1)
4.3 Semiannual compounding = /
+
×
/
+
++
/
+
+
P
C
r
C
r
C
r
M
r
2
1
2
2
1
2
....^2
1
2
1
2
0 12 22 nn
4.3a =
×−
P
C
r r
M
r
2
2
1
1
1
2
1
2
(^022) nn
keY TerMS
Australian government
bonds, 137
basis point, 144
bond ratings, 144
callable (bonds), 142
call price, 142
capital indexed bonds, 139
cash rate, 139
collateral, 140
collateral trust bond, 140
convertible bond, 141
corporate bonds, 137
coupon, 124
coupon rate, 124
coupon yield, 124
default risk, 135
debentures, 140
discount, 127
equipment trust certificate, 140
exchangeable bonds, 141
expectations theory, 149
face value (bonds), 124
floating-rate bonds, 138
indenture, 124
inflation linked bonds, 139
interest-rate risk, 131
junk bonds, 145
liquidity preference theory, 150
London Interbank Offered Rate
(LIBOR), 139
maturity date, 124
mortgage bond, 140
nominal return, 133
preferred habitat theory, 150
premium, 127
principal, 124
protective covenants, 142
pure discount bonds, 140
putable bonds, 142
real return, 133
required rate of return, 122
sinking fund, 142
spread, 139
subordinated unsecured debt, 139
term structure of interest rates,
147
Treasury bonds, 137
unsecured debt, 139
yield curve, 147
yield spread, 144
yield to maturity (YTM), 127
SeLF-TeST PrOBLeMS
Answers to Self-test problems and the Concept review questions throughout the chapter appear on
CourseMate with SmartFinance Tools at http://login.cengagebrain.com.
ST4-1 A five-year bond pays interest annually. Its face value is $1,000 and its coupon rate equals 7%. If the
market’s required return on the bond is 8%, what is the bond’s market price?