5) Bonds Flashcards
1
Q
What is a bond?
A
- a debt instrument whereby an investor lends money to an entity (like a company or a government) that borrows the funds for a defined period of time at a fixed interest rate
2
Q
Why may a company choose to issue bonds over borrowing from a bank?
A
- one may issue bonds to raise finance, perhaps to fund something
- in some cases, bonds may be cheaper in terms of interest rather than the bank loan that may be available
3
Q
What are ‘green bonds’? And why are they attractive to investors?
A
- bonds that are issued to fund activities that are environmentally responsible
- there are a subset of bonds that aim to conserve oceans -> known as ‘blue’ bonds
- they are attractive because they are a responsible form of investment so they reduce the cost to the issuer
4
Q
Which two major groups issue bonds?
A
- companies - issuing corporate bonds
- government - issuing government bonds
5
Q
Why do governments issue bonds?
A
- Many developed countries issue bonds as they often spend more in a given year than they receive in tax revenue e.g US, UK, Germany
- example: the UK govt sold 6bn of bonds called treasury gilts in nov 2022. The bonds will repay in 2038 and will pay interest of 3.75% each year
6
Q
What are the key features of bonds?
A
- a date when the bond will repay the money loaned and the frequency at which the interest payments will be made - % paid and how often it is paid
- the nominal value
- bonds are tradeable instruments that can be bought and sold before they reach their repayment date
7
Q
What is the nominal value of the bond?
A
- the amount that is owed by the bond issue, and that will be repaid on the repayment date
-aka face value because it is the value of the IOU - the interest rate is applied to the nominal value
8
Q
What is the redemption or maturity date?
A
- repayment date
9
Q
What is the bond yield? How do you calculate it?
A
the return an investor expects to receive each year over its term to maturity.
- the coupon only applies as the bond yield if the bond is being sold at its nominal price
- if the traded price rises above or below the nominal value, then the yield will be different from the coupon
- to calculate: dividend annual coupon by the price paid
10
Q
What happens to the bond yield if there is a fluctuation in interest rates or other required yields?
A
- if the interest rates generally increase after a bond issue, then to sell the bond, the yield will have to increase to attract any buyer. Only way this can happen is if the price is reduced
- if the interest rates fall, then buyers of the bond would be willing to accept a lower yield/return when they buy the bond and the price of the bond would increase.
- there is an inverse relationship between yield and bond.
11
Q
why are bond prices dependent on interest rates?
A
- bonds are susceptible to movements in general interest rates because for their yield to be attractive to investors, it needs to remain competitive with a return available on alternative investments
12
Q
what are the advantages of investing in bonds?
A
- provides a predictable income - bonds pay a stated amount of income annually or half year in the form of coupons (e annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity)
- bonds repay a set amount of cash at an agreed repayment date in the future so investors know how much and when the redemption date will occur `
13
Q
what is a disadvantage of investing bonds?
A
- comes with risk due to the possibility that issuer will fail to pay some or all of the coupons and the redemption amount because it doesn’t have available funds aka in default
14
Q
what does it mean if a company is in default?
A
- when they do not have the funds to continue to pay the coupons due or the redemption amount
- less substantial issuers are more likely to be in default than others
- ## rather than a complete default, just the possibility of an increased default can hurt the investor, resulting in a fall in the bond’s value, making it harder for an investor to sell (credit risk)
15
Q
what do credit rating agencies do?
A
- specialist agencies look at bond issuers and assess credit risk using a rating system
e.g. AAA = ‘extremely high capacity to meet their financial commitments’
