BKM 14: Bonds

Question 1

Par value

Answer 1

Face value of bond

Question 2

Coupon rate

Answer 2

Interest payment on bond

Question 3

Bond indenture

Answer 3

Contract between issuer and bondholder

Question 4

Accrued interest on bonds

Answer 4

If bond purchased between coupon payments, buyer must pay seller for accrued interest

Question 5

Callable bonds

Answer 5

Issued with call provisions allowing issuer to repurchase bond at specified call price; issued wiht higher coupons and promised YTMs than noncallables

Question 6

Convertible bonds

Answer 6

Gives bondholder option to exchange each bond for a specified number of common stock shares; lower coupons and stated or promised YTMs

Question 7

Conversion ratio

Answer 7

Ratio of shares for which each convertible bond can be exchanged

Question 8

Market conversion value

Answer 8

Current value of shares for which a convertible bond may be exchanged; conversion premium is excess of bond value over conversion value

Question 9

Puttable bond

Answer 9

Gives option to bondholder to extend or retire bond at the put date

Question 10

Floating-rate bonds

Answer 10

Make interest payments tied to some measure of current market rates; not adjusted for changes in financial condition of the firm

Question 11

Preferred stock

Answer 11

Receive dividends before common stockholders

Question 12

Foreign bond

Answer 12

Issued by a borrower from a country other than the one in which it is sold; denominated in marketed country’s currency

Question 13

Examples of foreign bonds

Answer 13

Yankee (foreign sold in US)

Samurai (foreign sold in Japan)

Bulldog (sold in UK)

Question 14

Eurobonds

Answer 14

Denominated in one currency but sold in other national markets

Question 15

Examples of Eurobonds

Answer 15

Eurodollar ($-denominated sold outside US)

Euroyen (yen-denominated selling outside of Japan)

Eurosterling (UK)

Question 16

Inverse floaters

Answer 16

Coupon rate falls when general level of interest rates rise

Question 17

Indexed bonds

Answer 17

Make payments tied to a general price index (ex: inflation)

Question 18

Nominal rate of return

Answer 18

(Interest + appreciation)/price

Question 19

Real return

Answer 19

(1 + Nominal) / (1 + Inflation) - 1

Question 20

Bond value in financial calculator

Answer 20

Question 21

Convexity

Answer 21

Progressive increases in interest rate result in progressively smaller reductions in bond price

Question 22

Yield to Maturity

Answer 22

Interest rate that makes PV of bond’s payments equal to price

Question 23

Current yield

Answer 23

Annual coupon payment divided by bond price

Question 24

Rule for bonds: coupon rate, current yield, and YTM

Answer 24

For premium bonds, coupon rate > current yield > YTM

Question 25

Yield to call

Answer 25

Just like YTM, except time to first call replaces time until maturity

Question 26

Realized compound return

Answer 26

Return realized at maturity date (not forecast)

Question 27

Offsetting risk of bonds as interest rates change

Answer 27

1. When rates rise, bond prices fall 2. When rates rise, coupons reinvested at higher rate

Question 28

Imputed interest

Answer 28

IRS method to determine tax; uses constant yield method (implied return vs. actual return)

Question 29

Credit risk

Answer 29

Risk of bond default

Question 30

Junk bonds

Answer 30

"Fallen angels" - originally investment grade "Original-issue junk"

Question 31

Key ratios to evaluate bond safety

Answer 31

1. Earnings to fixed costs (coverage) 2. Leverage ratio, debt-to-equity ratio 3. Liquidity ratios (current, quick) 4. Profitability ratios 5. Cash flow to debt ratio

Question 32

Altman ratio (bonds)

Answer 32

1.23 (bad) - 2.9 (safe)

Question 33

Sinking fund

Answer 33

Spreads payment of debt over several years

Question 34

Subordination of further debt

Answer 34

Restricts amount of additional borrowing

Question 35

Bond indenture examples

Answer 35

Sinking funds Subordination of further debt Dividend restrictions Collateral

Question 36

Default premium

Answer 36

Difference between promised yield and yield of an otherwise-identical government bond

Question 37

Credit default swap

Answer 37

An insurance policy on the default risk of a bond or loan; can effectively raise the quality of debt from lower to AAA Premium on swap should approximate yield spread Now used to speculate on issuer's financial health

Question 38

Collateralized debt obligation

Answer 38

Tool to reallocate credit risk by pooling and then tranching; used to create high-rated bonds from junk bonds