According to Bushong and Cornell (1992:46), “bonds are fixed-income securities issued by federal, state and local governments and their agencies and by corporations and they pay periodic interest at a specified rate during the bond term and return the full amount of principal at maturity”. A bond is a form of debt issued by a corporation. In exchange for a sum of money lent by the buyer of the bond, the issuer of the bond promises to pay a specific amount of interest at stated intervals for a specific period of time. At the end of repayment period (known as maturity), the issuing corporation repays the amount of money borrowed.
All bonds bear both a face value and a date of maturity. The face value is the amount one will receive when the bond reaches its date of maturity. The date of maturity is when the face value of the bond must be repaid. A bond bears an interest rate called the coupon rate. Calculating Value of a Bond When valuing a bond option, coupons can be treated as discrete dividend payments when valuing stock options. The periodic payment promised to the bondholders is the product of the coupon rate time times the bond’s face value. One calculates the bond value V(t) at time t with a time dependent but known interest rate r(t).
The bond investment value is equal to the present value of the interest and principal payments discounted at the straight (nonconvertible) bond interest rate. The difficult part of the calculation is estimating the discount rate. The interest rate used to discount the interest and principal payments reflect market rates of interest, which include a risk premium assigned by market forces. It is generally not too difficult to estimate the discount rate for investment-grade issues because bonds of similar quality tend to have similar interest rates.
However, below-investment-grade issues wit similar ratings can vary greatly. The investor must take into consideration the width of the spread on market interest rates for bonds with the same rating because that spread will affect the investment value of a convertible. Yield to Maturity (YTM) McGuigan, Moyer and Kretlow (2006) explain that the bond’s yield to maturity (YTM) is the in-house return rate of the bond, assuming that it is held to date of maturity and that it does not default.
The YTM of a bond is the rate of discount that connects the present value of all anticipated payments of interest and the settlement of principal from the bonds with the present price of the bond. There are a number of ways to compute the yield to maturity of a bond. Most financial calculators are programmed to compute the YTM. Also, special bond tables can be used to identify the YTM for any particular bond. YTM can be used to compare the risk of two or more bonds that are similar in all other respects, including time to maturity.
It is used in bond valuation through treating the bond with the higher YTM as riskier. Also, the YTM to maturity on existing bonds can be used as an estimate of the required returns of investors on any new (and similar) bonds the firm may issue. Eurobond and US Government Bond: A Comparison A Eurobond is a debt capital market instrument issued in “Eurocurrency” through a syndicate of issuing banks and securities houses, and distributed internationally when issued, that is sold in more than one country of issue and subsequently traded by market participants in several international financial centers (Madura, 2006).
A US government bond, on the other hand, is issued by the U. S. federal government, IOU that obligates the federal government to repay money that individuals have lent it, plus agreed upon interest, at a certain date. In the case of US government bonds, a vital issue involves the sources of competitive advantage of domestic organizations in Eurobond. Two differences are that Eurobonds offer high rates of return and high risks, while US government bonds offer low rates of return and low risks.
Further, investors in Eurobonds pay no withholding tax and hold bearer securities while it is the opposite with respect to US government bonds. WORKS CITED Bushong, J. & Cornell, D. (1992). The Use of Bonds in Financial Planning: How to Structure an Investment Portfolio to Meet Long-Term Needs. Journal of Accountancy. 173(5), 46+. Madura, J. (2006). International Financial Management. Mason, Ohio: Thomson South-Western. McGuigan, J. , Moyer, R. & Kretlow, W. (2006). Contemporary Financial Management. Mason, Ohio: Thomson South-Western.