Business 2019

Bonds
1. What is a Bond?

• It is a long-term secured debt financial security issued by a government or corporation.

• It is usually secured by physical or financial collateral (such as plant, equipment, or
securities).

2. What a bond is NOT!

• In this course when we use the term bond, we are not referring to Canada Savings Bonds
(CSBs)….CSBs are really savings certificates…they don’t carry fixed coupon rates nor are they
negotiable, nor are they issued for long periods of time (ie. 30 years).

3. What features do bonds possess that drive their market values and their price
‘behaviours’?

• Always have a par value per bond of $1,000

• Has a fixed coupon rate (ie. 6 percent coupon bond)
• Coupon interest is always paid semi-annually. (ie. A 6 percent coupon bond pays $30 every six
months throughout it’s life).
• The coupon rate is a fixed percent of the par or face value. (ie. 6 percent of $1,000 is $60 per
annum).
• Has a maturity date, hence, over time the life of the bond will decrease until it finally matures
and the bondholder on that date will receive the final coupon payment and the bond’s face
value.
• Is a negotiable security. (The bond can be traded among investors after it is originally sold).
• Because the bond is negotiable, it’s market value can change over time.
• Because all of the future cash flows (their timing, magnitude…and for the most part, their
riskiness) are known with a high degree of certainty in advance…the bond price is very
predictable given current interest rates.
• Because of the predictability of coupon payments and the par value, bond prices are very
sensitive to interest rates.
• Two major factors influence bond prices – general level of interest rates – financial health of the
corporate issuer (as evidenced by the bond rating)

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4. Why are bonds so useful to corporations as a long-term source of financing?

• The coupon interest rate will not change over that entire period of time...this means that as long
as the firm was confident that it could earn a return on these funds in excess of the coupon rate,
the firm’s value should be enhanced.

5. The ‘down side’ of Bonds from the Corporate Issuer’s Perspective

• once the bonds have been sold, the corporation is responsible for fulfilling all of the indenture
provisions of the bonds (payment of the coupon interest, maintenance of ratios, contributions to
a sinking fund perhaps, etc.) over their entire life (for as many as 30 years). Default on any of
the terms or conditions of the bond indenture is an act of bankruptcy.
• If the indenture puts restrictions on the ability of the firm to seek further debt financing this
could force the firm to forego profitable opportunities in the future.

6. Finding the ‘intrinsic’ value of a bond (inherent worth…and therefore equilibrium

market value)

• The value of a bond is equal to the sum of the discounted cash flows that it offers from now till
maturity.
• First there is an annuity stream of coupon interest payments, and finally on the date of maturity
there is the return of the bonds par value:

Value = $C(PVIFAt,r) + $1,000(PVIFt,r)

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 7. Bond Quotations

BONDS
Supplied by RBC Dominion Securities Inc.
International from Reuters
Coupon Mat. Date Bid $ Yld% Coupon Mat. Date Bid $ Yld%
Canada 4.500 Dec 01/80 98.95 17.80 Corporate
Canada 4.000 May 01/81 94.14 16.70 Avco 7.800 Sep 15/86 73.74 14.50
Canada 4.250 Nov 01/81 90.02 15.40 BC Gas 6.580 Dec 14/89 66.91 12.90
Canada 6.300 Nov 01/83 81.90 13.90 BC Gas 10.500 May 14/95 91.61 11.70
Canada 8.200 Nov 01/85 86.02 12.00 BC Gas 14.000 Mar 1/90 116.26 11.25
Canada 6.900 Nov 01/90 88.30 8.68 BC Tel 13.500 Aug 1/95 111.83 11.80
Canada 8.100 Nov 01/95 99.83 8.12 BCE 12.250 Feb 1/98 120.53 9.80
Canada 9.300 Nov 01/00 118.49 7.50 Bell 6.850 Apr 15/84 80.74 13.20
Canada 10.250 Nov 01/05 133.68 7.30 Bell 7.100 Apr 15/88 78.26 11.30
Canada 14.000 Nov 01/10 183.13 7.20 Bell 7.250 Apr 15/92 82.23 9.80
CMHC 5.000 Jun 01/98 72.77 10.03 BMO 7.500 Jun 01/85 81.5 12.60
EDC 5.500 Apr 30/88 63.40 12.99 BMO 8.250 Jun 01/88 91.54 9.80

Source: Financial Post, November 2, 1980, p. c22

8. Current Yield

• Current Yield = Annual Coupon Interest divided by current market price of the bond.

9. Yield to Maturity

• Is the discount rate that equates the current market price of the bond with the expected cash
flows that the bond offers (it is also known as an internal rate of return)
• This is an ex ante calculation…and as such, it involves making a serious assumption about
the reinvestment rate that will be used by the investor when investing the intermediate cash
flows (the coupon interest that will be received semi-annually till the bond matures.)
• It can be found in a number of alternative ways:
a) Iteratively … keep substituting different rates until you get the current market
price to equal the sum of the discounted value of all future cash flows.
b) Financial calculator
c) Use of Excel Spreadsheet
d) Use of Approximation Formula

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