Accounting: Interest and Bond

8256 words 34 pages
Part 3
Valuation of Securities
Chapters in this Part
Chapter 6

Interest Rates and Bond Valuation

Chapter 7

Stock Valuation

Integrative Case 3: Encore International

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 6
Interest Rates and Bond Valuation


Instructor’s Resources

Overview
This chapter begins with a thorough discussion of interest rates, yield curves, and their relationship to required returns. Features of the major types of bond issues are presented along with their legal issues, risk characteristics, and indenture convents. The chapter then introduces students to the important concept of valuation and demonstrates the impact of cash flows, timing, and risk on value. It explains
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The nominal rate of interest for a security can be defined as r1 = r + IP + RP.
*
For a 3-month U.S. Treasury bill, the nominal rate of interest can be stated as r1 = r + IP. The default risk premium, RP, is assumed to be zero since the security is backed by the U.S. government; this security is commonly considered the risk-free asset.
2. The term structure of interest rates is the relationship of the rate of return to the time to maturity for any class of similar-risk securities. The graphic presentation of this relationship is the yield curve.

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

104

Gitman/Zutter • Principles of Managerial Finance, Thirteenth Edition

3. For a given class of securities, the slope of the curve reflects an expectation about the movement of interest rates over time. The most commonly used class of securities is U.S. Treasury securities.
a. Downward sloping: Long-term borrowing costs are lower than short-term borrowing costs.
b. Upward sloping: Short-term borrowing costs are lower than long-term borrowing costs.
c. Flat: Borrowing costs are relatively similar for short- and long-term loans.
The upward-sloping yield curve has been the most prevalent historically.
4. a.

According to the expectations

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