Summary And Conclusions

This chapter has explored bonds, bond yields, and interest rates. We saw that:

1. Determining bond prices and yields is an application of basic discounted cash flow principles.

2. Bond values move in the direction opposite that of interest rates, leading to potential gains or losses for bond investors.

3. Bonds have a variety of features spelled out in a document called the indenture.

4. Bonds are rated based on their default risk. Some bonds, such as Treasury bonds, have no risk of default, whereas so-called junk bonds have substantial default risk.

5. A wide variety of bonds exist, many of which contain exotic or unusual features.

6. Almost all bond trading is OTC, with little or no market transparency. As a result, bond price and volume information can be difficult to find.

7. Bond yields and interest rates reflect the effect of six different things: the real interest rate and five premiums that investors demand as compensation for inflation, interest rate risk, default risk, taxability, and lack of liquidity.

In closing, we note that bonds are a vital source of financing to governments and corporations of all types. Bond prices and yields are a rich subject, and our one chapter, necessarily, touches on only the most important concepts and ideas. There is a great deal more we could say, but, instead, we will move on to stocks in our next chapter.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

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