Thank you

I would like to take this opportunity to thank all my dear students for the time spent browsing my site and I hope that you found this site interesting and knowledgeable. I hope you will keep on visiting this site and support my intention to bring the best education to you and to the next generation.

Thank you, thank you and thank you.

I pray for your success and good luck to everything you do.


BUACC3701 – Shareholder Value and Cost of Equity

First of all, I will focus on the shareholder value topic before I proceed to the cost of equity topic.

What shareholder value is really about?

This blog post is part of the HBR Online Forum The CEO’s Role in Fixing the System.

Most CEOs, as well as some of the other contributors to this forum, appear to have a false sense of what creating shareholder value means. CEOs need to understand the principles of shareholder value and why they are so important in judging difficult trade-offs, learn about the relationship between the financial performance of the company and the company’s stock, and communicate clearly and act appropriately when expectations gaps open.

It is now in vogue to dismiss the idea that creating shareholder value should be a CEO’s guiding objective. Concepts like “societal value,” “shared value,” and “customer capitalism” are offered as desirable and more enlightened substitutes. This is muddled thinking. CEOs who understand the principles of shareholder value and execute effectively will satisfy most, if not all, of the objectives of those who call for a new way of thinking. The problem is that the true definition of creating shareholder value seems to have gotten lost.

A CEO must understand three issues to be effective. First, he or she needs to internalize the true meaning of creating shareholder value. This amounts to a collection of principles that guide strategic, financial, and organizational issues. Second, he or she needs to understand how capital markets work. Finally, he or she must communicate effectively to shareholders, as well as to other stakeholders.

Creating Shareholder Value

Critics imply that managing for shareholder value is all about maximizing the short-term stock price. Companies that manage for shareholder value, the thinking goes, do whatever it takes to engineer an ever-higher market price. That is a profound misunderstanding. The premise of shareholder value, properly understood, is that if a company builds value, the stock price will eventually follow. The objective is to build value and then let the price reflect that value.

While some executives allow that they should not manage to increase the short-term stock price, they remain reluctant to embrace the concept of managing for shareholder value. It is worth explaining why this is the right objective, and how other stakeholders — including employees, customers, and suppliers — fit into the picture.

A CEO’s job is about resource allocation with a goal of earning a return in excess of the opportunity cost of capital. This requires difficult trade-offs. The challenge is figuring out how to allocate human and financial capital to its best and highest use for the long term. Value creation, by means of maximizing long-term free cash flow, provides the appropriate approach to judge alternative strategies and subsequent performance.

Here’s where other stakeholders come in. To maximize long-term free cash flow, a company must properly manage its relationships with all of its stakeholders. For instance, companies that charge too much for their goods or services will lose customers to the competition. Companies that charge too little may have happy customers but will be unable to meet their other financial obligations or offer new and improved products and services to customers. So a successful shareholder value-oriented company must find the price that adds value for both customers and shareholders.

Similarly, paying employees too little ensures a substandard workforce in a competitive world. Paying employees too much, as the U.S. auto companies discovered, hampers a company’s ability to remain competitive. The same logic extends to suppliers and the government.

The shareholder value approach acknowledges the tough choices that corporate executives face, and gives them a means to decide between them. But one point should be abundantly clear: A company cannot maximize shareholder value through systematic exploitation of its stakeholders.

Understanding Capital Markets

Almost without fail, individuals who get promoted to the position of CEO have been highly successful in some part of the corporation. They may have effectively run a large division or devised a winning marketing strategy. But the fact is, most CEOs have a poor understanding of how the stock market works. The skills and effort that catapulted them to the top spot typically do not prepare them to deal with markets and investors.

An enlightened CEO learns how the stock market sets prices. The research in this area points to three salient points:

First, the value of the business is the present value of future cash flows. In the very long haul, earnings and cash flow converge. But in the short run, cash flows and earnings can be very different. Notwithstanding a nearly ubiquitous focus on earnings and earnings per share, the informed CEO will focus on long-term cash flow.

Second, the stock market reflects cash flows many years into the future — it is long-term oriented. Let me say that again: No matter what you hear about short-term focused investors, values in the stock market are driven by long-term cash flows. Essentially, investors make short-term bets on long-term outcomes. The way to convince yourself of this is to build a spreadsheet and see for yourself. It is not uncommon for it to take 10 or more years of value-creating cash flows to justify a company’s stock price.

Third, the market pays for value creation. Take M&A as an example. Most deals are additive to earnings but destroy value. But research shows that if the synergies of combining businesses exceed the premium the acquirer pays, the stock of the acquiring company goes up irrespective of the immediate earnings impact — and the reverse is true as well.

CEOs often pay attention to analysts, investment bankers, or the media to try to understand the market. None of these are good sources because they represent a small percentage of the collective information that prices capture. A CEO who doesn’t take the time to understand markets is at risk of being influenced by individuals who have incentives that are not aligned with the goals of the company.


A company’s stock price conveys useful information about the expectations for future financial performance. Executives can reverse engineer those expectations, generally expressed through value drivers, and compare them to the company’s internal forecasts. (Value drivers include sales growth, operating profit margin, and investment requirements.) Large gaps between what the market believes and what the company believes represent an opportunity for communication or action.

If a company perceives that the market has the expectations wrong, the CEO can discuss the key value drivers of the business with the financial community in order to narrow the gap. If the market doesn’t respond, management can take action to benefit from the value gap. For example, if the shares are undervalued, management can buy back shares. If the shares are overvalued, management can issue them as currency for an acquisition.

There is no reason to scrap the notion of creating shareholder value. If anything, it is more important now than ever. The problem is that the concept is broadly misunderstood. CEOs need to grasp what creating shareholder value is really about and to have the fortitude to implement strategies to create long-term value.


Michael Mauboussin is an investment strategist and an adjunct professor at Columbia Business School. His latest book is The Success Equation.


And….. this is a debate. Something to look on. Watch and I need your views on this.

















BUACC3701 – Project Cash Flows and Incremental Cash Flows

Part two or continuity from the previous posting regarding the capital investment decisions. We shall look into the projected cashflow. The cashflow plays an important tole in determining the viability of the undertaken project. Basic rule is by applying the NPV method that we’ve learned previously. That’s basic. Here I just want to share the deatils about it. Again, I’ve browsed the net from the same page, well I think you also can do that…

When beginning capital-budgeting analysis, it is important to determine a project’s cash flows. These cash flows can be segmented as follows:

1. Initial Investment Outlay
These are the costs that are needed to start the project, such as new equipment, installation, etc.

2. Operating Cash Flow over a Project’s Life
This is the additional cash flow a new project generates.

3. Terminal-Year Cash Flow
This is the final cash flow, both the inflows and outflows, at the end of the project’s life; for example, potential salvage value at the end of a machine’s life. Example: Expansion Project
Newco wants to add to its production capacity and is looking closely at investing in Machine B. Machine B has a cost of $2,000, with shipping and installation expenses of $500 and a $300 cost in net working capital. Newco expects the machine to last for five years, at which point Machine B will have a book value (BV) of $1,000 ($2,000 minus five years of $200 annual depreciation) and a potential market value of $800.

With respect to cash flows, Newco expects the new machine to generate an additional $1,500 in revenues and costs of $200. We will assume Newco has a tax rate of 40%. The maximum payback period that the company has established is five years.

Let’s calculate the project’s initial investment outlay, operating cash flow over the project’s life and the terminal-year cash flow for the expansion project.

Initial Investment Outlay
Machine cost + shipping and installation expenses + change in net working capital = $2,000 + $500 + $300 = $2,800

Operating Cash Flow:
CFt = (revenues – costs)*(1 – tax rate)
CF1 = ($1,500 – $200)*(1 – 40%) = $780
CF2 = ($1,500 – $200)*(1 – 40%) = $780
CF3 = ($1,500 – $200)*(1 – 40%) = $780
CF4 = ($1,500 – $200)*(1 – 40%) = $780
CF5 = ($1,500 – $200)*(1 – 40%) = $780

Terminal Cash Flow: 

Tips and Tricks
The key metrics for determining the terminal cash flow are salvage value of the asset, net working capital and tax benefit/loss from the asset.

The terminal cash flow can be calculated as illustrated:

Return of net working capital +$300
Salvage value of the machine +$800
Tax reduction from loss (salvage < BV) +$80
Net terminal cash flow $1,180
Operating CF5+$780
Total year-five cash flow $1,960

For determining the tax benefit or loss, a benefit is received if the book value of the asset is more than the salvage value, and a tax loss is recorded if the book value of the asset is less than the salvage value.

Read more: Project Cash Flows
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Incremental cash flow is the additional operating cash flow that an organization receives from taking on a new project. A positive incremental cash flow means that the company’s cash flow will increase with the acceptance of the project.

There are several components that must be identified when looking at incremental cash flows: the initial outlay, cash flows from taking on the project, terminal cost (or value) and the scale and timing of the project. A positive incremental cash flow is a good indication that an organization should spend some time and money investing in the project.

Incremental Cash Flow and Capital Budgeting
When determining incremental cash flows from a new project, several problems arise: sunk costs, opportunity costs, externalities and cannibalization.

1. Sunk Costs
These are the initial outlays required to analyze a project that cannot be recovered even if a project is accepted. As such, these costs will not affect the future cash flows of the project and should not be considered when making capital-budgeting decisions.

Suppose Newco is considering whether to make an addition to its current plant to increase production. To determine if the new addition is worthwhile, Newco hired a consulting firm for $50,000 to analyze the addition and the effect it will have on production. The $50,000 is considered a sunk cost. If the project is rejected, the $50,000 will still be paid, and if the project is accepted, the $50,000 will not affect the future cash flows of the addition.

2. Opportunity Cost
This is the cost of not going forward with a project or the cash outflows that will not be earned as a result of utilizing an asset for another alternative. For example, the opportunity cost of Newco’s new addition considered above is the cost of the land on which the company is considering putting the new plant addition. As such, it should be included in the analysis of the project.

3. Externality
In the consideration of incremental cash flows of a new project, there may be effects on the existing operations of the company to consider, known as “externalities.” For example, the addition to Newco’s plant is for the purpose of producing a new product. It must be considered whether the new product may actually take away or add to sales of the existing product.

4. Cannibalization
Cannibalization is the type of externality where the new project takes sales away from the existing product.

Changes in Net Working Capital
A change in net working capital is essentially the changes in current assets minus changes in current liabilities. Within the capital-budgeting process, a project typically adds to current assets given additional inventories or potential increases in accounts receivables from new sales. The increases to current assets, however, are offset by current liabilities needed to finance the new project.

Overall, there may be a change to net working capital from the new project.

  • If the change in net working capital is positive, the change to current assets outweighs the change in the current liabilities.
  • If, however, the change in net working capital is negative, the change to current liabilities outweighs the change in current assets.

Read more: Incremental Cash Flows
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BUACC3710 – Capital Investment Decisions

This is an interesting topic…. but due to my busy schedule, I have browsed the net and found this in investopedia page…

Capital investments are funds invested in a firm or enterprise for the purposes of furthering its business objectives. Capital investment may also refer to a firm’s acquisition of capital assets or fixed assets such as manufacturing plants and machinery that are expected to be productive over many years. Sources of capital investment are manifold and can include equity investors, banks, financial institutions, venture capital and angel investors. While capital investment is usually earmarked for capital or long-life assets, a portion may also be used for working capital purposes.

Capital investment encompasses a wide variety of funding options. While funding for capital investment is generally in the form of common or preferred equity issuance, it may also be through straight or convertible debt. Funding may range from an amount of less than $100,000 in seed financing for a start-up to amounts in the hundreds of millions for massive projects in capital-intensive sectors like mining, utilities and infrastructure.

In this section, we’ll examine various components of a company’s capital investment decisions, including project cash flows, incremental cash flows and more.

Read more: Introduction To Capital Investment Decisions
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Download this for your notes…

Week 6a

Week 6b



BUACC 3701 – Type of bonds and valuing them

Before I actually elaborate…watch this first….

This section describes the various types of bonds that a company might issue. (To learn about government-issued bonds, read Basics Of Federal Bond IssuesSavings Bonds For Income And Safety and 20 Investments: Municipal Bonds.)

Corporate Bonds
A company can issue bonds just as it can issue stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear. Generally, a short-term corporate bond has a maturity of less than five years, intermediate is five to 12 years and long term is more than 12 years.

Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. The upside is that they can also be the most rewarding fixed-income investments because of the risk the investor must take on. The company’s credit quality is very important: the higher the quality, the lower the interest rate the investor receives.

Variations on corporate bonds include convertible bonds, which the holder can convert into stock, and callable bonds, which allow the company to redeem an issue prior to maturity.

Convertible Bonds
convertible bond may be redeemed for a predetermined amount of the company’s equity at certain times during its life, usually at the discretion of the bondholder. Convertibles are sometimes called “CVs.”

Issuing convertible bonds is one way for a company to minimize negative investor interpretation of its corporate actions. For example, if an already public company chooses to issue stock, the market usually interprets this as a sign that the company’s share price is somewhat overvalued. To avoid this negative impression, the company may choose to issue convertible bonds, which bondholders will likely convert to equity should the company continue to do well.

From the investor’s perspective, a convertible bond has a value-added component built into it: it is essentially a bond with a stock option hidden inside. Thus, it tends to offer a lower rate of return in exchange for the value of the option to trade the bond into stock.

Callable Bonds
Callable bonds, also known as “redeemable bonds,” can be redeemed by the issuer prior to maturity. Usually a premium is paid to the bond owner when the bond is called.

The main cause of a call is a decline in interest rates. If interest rates have declined since a company first issued the bonds, it will likely want to refinance this debt at a lower rate. In this case, the company will call its current bonds and reissue new, lower-interest bonds to save money.

Term Bonds
Term bonds are bonds from the same issue that share the same maturity dates. Term bonds that have a call feature can be redeemed at an earlier date than the other issued bonds. A call feature, or call provision, is an agreement that bond issuers make with buyers. This agreement is called an “indenture,” which is the schedule and the price of redemptions, plus the maturity dates.

Some corporate and municipal bonds are examples of term bonds that have 10-year call features. This means the issuer of the bond can redeem it at a predetermined price at specific times before the bond matures.

A term bond is the opposite of a serial bond, which has various maturity schedules at regular intervals until the issue is retired.

Amortized Bonds
An amortized bond is a financial certificate that has been reduced in value for records on accounting statements. An amortized bond is treated as an asset, with the discount amount being amortized to interest expense over the life of the bond. If a bond is issued at a discount – that is, offered for sale below its par (face value) – the discount must either be treated as an expense or amortized as an asset.

As we discussed in Section 4, amortization is an accounting method that gradually and systematically reduces the cost value of a limited life, intangible asset. Treating a bond as an amortized asset is an accounting method in the handling of bonds. Amortizing allows bond issuers to treat the bond discount as an asset until the bond’s maturity. (To learn more about bond premium amortization, read Premium Bonds: Problems And Opportunities.)

Adjustment Bonds
Issued by a corporation during a restructuring phase, an adjustment bond is given to the bondholders of an outstanding bond issue prior to the restructuring. The debt obligation is consolidated and transferred from the outstanding bond issue to the adjustment bond. This process is effectively a recapitalization of the company’s outstanding debt obligations, which is accomplished by adjusting the terms (such as interest rates and lengths to maturity) to increase the likelihood that the company will be able to meet its obligations.

If a company is near bankruptcy and requires protection from creditors (Chapter 11), it is likely unable to make payments on its debt obligations. If this is the case, the company will be liquidated, and the company’s value will be spread among its creditors. However, creditors will generally only receive a fraction of their original loans to the company. Creditors and the company will work together to recapitalize debt obligations so that the company is able to meet its obligations and continue operations, thus increasing the value that creditors will receive.

Junk Bonds
junk bond, also known as a “high-yield bond” or “speculative bond,” is a bond rated “BB” or lower because of its high default risk. Junk bonds typically offer interest rates three to four percentage points higher than safer government issues.

Angel Bonds
Angel bonds are investment-grade bonds that pay a lower interest rate because of the issuing company’s high credit rating. Angel bonds are the opposite of fallen angels, which are bonds that have been given a “junk” rating and are therefore much more risky.

An investment-grade bond is rated at minimum “BBB” by S&P and Fitch, and “Baa” by Moody’s. If the company’s ability to pay back the bond’s principal is reduced, the bond rating may fall below investment-grade minimums and become a fallen angel.

and lastly…….









James Bond

This bond I can eloborate more than all the above mentioned bonds. And I know you’ll like it. You can do so much research on this type of bond. This is also one of the investment. Hahaha. Therefore, I would like to share the history of bonds since 1962…

Image result for james bond



Read more: Types Of Bonds
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Ok…enough of that, now let’s proceed to Valuing of Bonds

The fundamental principle of bond valuation is that the bond’s value is equal to the present value of its expected (future) cash flows. The valuation process involves the following three steps:

1. Estimate the expected cash flows.
2. Determine the appropriate interest rate or interest rates that should be used to discount the cash flows.
3. Calculate the present value of the expected cash flows found in step one by using the interest rate or interest rates determined in step two.

Determining Appropriate Interest Rates
The minimum interest rate that an investor should accept is the yield for a risk-free bond (a Treasury bond for a U.S. investor). The Treasury security that is most often used is the on-the-run issue because it reflects the latest yields and is the most liquid.

For non-Treasury bonds, such as corporate bonds, the rate or yield that would be required would be the on-the-run government security rate plus a premium that accounts for the additional risks that come with non-Treasury bonds.

As for the maturity, an investor could just use the final maturity date of the issue compared to the Treasury security. However, because each cash flow is unique in its timing, it would be better to use the maturity that matches each of the individual cash flows.

Computing a Bond’s Value
First, we need to find the present value (PV) of the bond’s future cash flows. The present value is the amount that would have to be invested today to generate that future cash flow. PV is dependent on the timing of the cash flow and the interest rate used to calculate the present value. To figure out the value, the PV of each individual cash flow must be found. Then, just add the figures together to determine the bond’s price.

PV at time T = expected cash flows in period T / (1 + I) to the T power

After you calculate the expected cash flows, you will need to add the individual cash flows:

Value = present value @ T1 + present value @ T2 + present value @Tn

Let’s throw some numbers around to further illustrate this concept.

Example: The Value of a Bond
Bond GHJ matures in five years with a coupon rate of 7% and a maturity value of $1,000. For simplicity’s sake, let’s assume that the bond pays annually and the discount rate is 5%.

The cash flow for each of the years is as follows:
Year One = $70

Year Two = $70

Year Three = $70

Year Four = $70

Year Five = $1,070

Thus, the PV of the cash flows is as follows:

Year One = $70 / (1.05) to the 1st power = $66.67
Year Two = $70 / (1.05) to the 2nd power = $ 63.49
Year Three = $70 / (1.05) to the 3rd power = $ 60.47
Year Four = $70 / (1.05) to the 4th power = $ 57.59
Year Five = $1,070 / (1.05) to the 5th power = $ 838.37

Now to find the value of the bond:
Value = $66.67 + $63.49 + $60.47 + $57.59 + $838.37
Value = $1,086.59

How Does the Value of a Bond Change?

As rates increase or decrease, the discount rate that is used also changes. Let’s change the discount rate in the above example to 10% to see how it affects the bond’s value.

Example: The Value of a Bond when Discount Rates Change
PV of the cash flows is:
Year One = $70 / (1.10) to the 1st power = $ 63.63
Year Two = $70 / (1.10) to the 2nd power = $ 57.85
Year Three = $70 / (1.10) to the 3rd power = $ 52.63
Year Four = $70 / (1.10) to the 4th power = $ 47.81
Year Five = $1,070 / (1.10) to the 5th power = $ 664.60

Value = 63.63 + 57.85 + 52.63 + 47.81 + 664.60 = $ 886.52

  • As we can see from the above examples, an important property of PV is that for a given discount rate, the older a cash flow value is, the lower its present value.
  • We can also compute the change in value from an increase in the discount rate used in our example. The change = $1,086.59 – $886.52 = $200.07.
  • Another property of PV is that the higher the discount rate, the lower the value of a bond; the lower the discount rate, the higher the value of the bond.
Look Out!

If the discount rate is higher than the coupon rate the PV will be less than par. If the discount rate is lower than the coupon rate, the PV will be higher than par value.

How Does a Bond’s Price Change as it Approaches its Maturity Date?
As a bond moves closer to its maturity date, its price will move closer to par. There are three possible scenarios:

1.If a bond is at a premium, the price will decline over time toward its par value.
2. If a bond is at a discount, the price will increase over time toward its par value.
3. If a bond is at par, its price will remain the same.

To show how this works, let’s use our original example of the 7% bond, but now let’s assume that a year has passed and the discount rate remains the same at 5%.

Example: Price Changes Over Time
Let’s compute the new value to see how the price moves closer to par. You should also be able to see how the amount by which the bond price changes is attributed to it being closer to its maturity date.

PV of the cash flows is:
Year One = $70 / (1.05) to the 1st power = $66.67
Year Two = $70 / (1.05) to the 2nd power = $ 63.49
Year Three = $70 / (1.05) to the 3rd power = $ 60.47
Year Four = $1,070 / (1.05) to the 4th power = $880.29

Value = $66.67 + $63.49 + $60.47 + $880.29 = $1,070.92

As the price of the bond decreases, it moves closer to its par value. The amount of change attributed to the year’s difference is $15.67.

An individual can also decompose the change that results when a bond approaches its maturity date and the discount rate changes. This is accomplished by first taking the net change in the price that reflects the change in maturity, then adding it to the change in the discount rate. The two figures should equal the overall change in the bond’s price.

Computing the Value of a Zero-coupon Bond
A zero-coupon bond may be the easiest of securities to value because there is only one cash flow – the maturity value.

The formula to calculate the value of a zero coupon bond that matures N years from now is as follows:

Maturity value / (1 + I) to the power of the number of years * 2
Where I is the semi-annual discount rate.

Example: The Value of a Zero-Coupon Bond
For illustration purposes, let’s look at a zero coupon with a maturity of three years and a maturity value of $1,000 discounted at 7%.

I = 0.035 (.07 / 2)
N = 3

Value of a Zero-Coupon Bond

= $1,000 / (1.035) to the 6th power (3*2)
= $1,000 / 1.229255
= $813.50

Arbitrage-free Valuation Approach
Under a traditional approach to valuing a bond, it is typical to view the security as a single package of cash flows, discounting the entire issue with one discount rate. Under the arbitrage-free valuation approach, the issue is instead viewed as various zero-coupon bonds that should be valued individually and added together to determine value. The reason this is the correct way to value a bond is that it does not allow a risk-free profit to be generated by “stripping” the security and selling the parts at a higher price than purchasing the security in the market.

As an example, a five-year bond that pays semi-annual interest would have 11 separate cash flows and would be valued using the appropriate yield on the curve that matches its maturity. So the markets implement this approach by determining the theoretical rate the U.S. Treasury would have to pay on a zero-coupon treasury for each maturity. The investor then determines the value of all the different payments using the theoretical rate and adds them together. This zero-coupon rate is the Treasury spot rate. The value of the bond based on the spot rates is the arbitrage-free value.

Determining Whether a Bond Is Under or Over Valued 
What you need to be able to do is value a bond like we have done before using the more traditional method of applying one discount rate to the security. The twist here, however, is that instead of using one rate, you will use whatever rate the spot curve has that coordinates with the proper maturity. You will then add the values up as you did previously to get the value of the bond.

You will then be given a market price to compare to the value that you derived from your work. If the market price is above your figure, then the bond is undervalued and you should buy the issue. If the market price is below your price, then the bond is overvalued and you should sell the issue.

How Bond Coupon Rates and Market Rates Affect Bond Price
If a bond’s coupon rate is above the yield required by the market, the bond will trade above its par value or at a premium. This will occur because investors will be willing to pay a higher price to achieve the additional yield. As investors continue to buy the bond, the yield will decrease until it reaches market equilibrium. Remember that as yields decrease, bond prices rise.

  • If a bond’s coupon rate is below the yield required by the market, the bond will trade below its par value or at a discount. This happens because investors will not buy this bond at par when other issues are offering higher coupon rates, so yields will have to increase, which means the bond price will drop to induce investors to purchase these bonds. Remember that as yields increase, bond prices fall.

Read more: Bond Valuation
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Accounting reference lists…

I just wandering around, browsing for some songs and some accounting information while finishing on something that I really need to do. Sigh! BUT I came across some good sites for students to do some researching or knowledge seeking. Websites, videos, slides etc…So I will post some first and maybe if I have time, I will continue to contribute here…


Week 5 – Valuing Shares and Bonds

Bonds are an investment ‘asset’ and their price (or value or worth) is the present value of their future cash flows. The bond contract is a special kind of business agreement. The deed of trust (bond indenture) states the explicit terms of the agreement such as the (fixed) coupon rate and the face value to be paid on the bond. The legal effect of having the agreement enshrined in a deed of trust rather than a contract of sale, means that the bond carries a stronger security of claim and lower probability of default risk. The economic effect of the trust deed means that the bond purchaser gains greater certainty over the cash flows the bond will generate. The bond must be held to maturity for it to generate the quoted yield.  The bond price remains subject to interest rate changes in the market.

The inverse relationship between interest rates and values is particularly relevant to bond markets.  If interest rates surge because of unexpected rises in inflation for example, bond prices fall analogously.  Bondholders then face the double stress of a lower bond value and lower interest income on their fixed-rate investment. Conversely, if there is a surge in demand for bonds, their yields may fall. This phenomenon has been recently reported in the US Junk bond market (BBB credit rating and below). Investors who were reportedly unhappy with the low returns being paid on secure bonds, increased their demand for riskier securities. They reportedly spent $US4.6 billion in the first six weeks of 2011 in the BBB-rated and below bond markets. This sent the high-risk class of bond yields down to extremely low levels.


Essentially, the market pricing mechanism ensures that everyone gets the same deal no matter what coupon interest rate the issuer is paying. If the bond coupon rate is above the market average, you have to pay more for the bond; if the bond coupon rate is below the market average, you pay less for the bond; and if the bond coupon rate is equal to the market average, you pay the same as the face value of the bond.

Here are some slides and notes for bonds.



Week 5a

Week 5 (Ch 6) Tutorial Questions

So another alternative for a company to raise funds is issuing stocks (shares). Take alook at this video…


Try to understand that first and we shall discuss later when we meet. Next, maybe I will touch a bit regarding the type of bonds…