BOND VALUATION & INTEREST RATES

Question 1

What is a bullet payment or ballon payment

Answer 1

A principal payment made in one lump sum at maturity

Question 2

What is a Bond Indenture ?

Answer 2

legal document that specifies the payment requirements and all other salient matters relating to a particular bond issue, held and administered by a trust company

Question 3

what is a Fiduciary?

Answer 3

fiduciary is a third party who acts to ensure the best interests of bondholders are upheld
(involving trust, especially with regard to the relationship between a trustee and a beneficiary.
“the company has a fiduciary duty to shareholders”)

Question 4

Covent provisions?

Answer 4

Clauses within the indenture that lay out the legal rights of the bondholder and the obligations of the issuer

Question 5

What are debenditures?

Answer 5

debt instruments that are similar to bonds but are generally unsecured or are secured by a general floating charge over the company’s unencumbered assets

Question 6

Callable bonds?

Answer 6

Bonds that the company can call back at a predetermined price(generally at a premium over par) A condition for a company to call back its bonds is that market rates have declined. These bonds create additional risk to the bondholder; hence, the call price usually exceeds the par value to provide an incentive for investors to buy the bond initially.
(Call price = redemption price)

Question 7

What is a bond duration?

Answer 7

The duration (Macaulay Duration) is an important measure of interest rate risk that incorporates several factors.

Question 8

What is the current yield (CY) formula?

Answer 8

CY= (Annual interest/B)

Question 9

What is the liquidity premium?

Answer 9

Additional yield offered on bonds that are less liquid.

Question 10

what are issue-specific premiums?

Answer 10

issue-specific premiums are premiums that arise when bonds have features that cause them to be more or less attractive to investors, relative to straight(option-free) bonds.

Question 11

What is a Floating Rate Bond(Floater)?

Answer 11

Floaters have adjustable coupons that are usually tied to some variable short-term rate, such as the T-bill rate, although many variations exist.Differ significantly from traditional fixed-income bonds, because coupon rates increase as interest rates increase.

Floaters provide protection against rising interest rates and tend to trade near their par value.

Question 12

Why is it that when a bond is at a discount, the coupon rate is less than the current yield, which is less than YTM?

Answer 12

Current yield is the ratio of the annual coupon divided by the current market price. Coupon rate is the ratio of annual coupon divided by the face value. When a bond is at discount, the price is less than the face value. Therefore, the coupon rate is less than the current yield.

Question 13

What is the Yield to Call YTC?

Answer 13

Yield to call (YTC) is a financial term that refers to the return a bondholder receives if the bond is held until the call date, which occurs sometime before it reaches maturity.

Question 14

What is the difference between a positive and a negative covenant provision?

Answer 14

Negative covenants prohibit certain actions, for example, a company may be restricted from making a dividend payment larger than a certain amount or prevented from pledging its assets to another lender. Positive covenants specify actions that the firm agrees to undertake, for example, to provide quarterly financial statements or maintain certain working capital levels.

Question 15

How do sinking funds work?

Answer 15

There are two ways in which this is done. In the first way, the firm repurchases a certain amount of debt each year so that the amount of debt actually goes down. In the second way, the firm pays money into the sinking fund to buy other bonds, usually government bonds, so that money is available at maturity to pay off the debt, although the amount due at maturity is unchanged.

Question 16

Why do interest rates differ between Canada and the United States?

Answer 16

Interest rates are heavily influenced by inflation and other domestic macroeconomic variables; global factors such as foreign exchange rates and inflation differentials also play an important role in the level of interest rates at any given point in time.

Question 17

How do U.S. bank discount yields differ from bond equivalent yields?

Answer 17

The formulas are k_BEY=(F-P)/P×365/n x 100 and k_BDY=(F-P)/F×360/n×100 individually.

Question 18

How do floaters and Real Return Bonds provide protection against inflation?

Answer 18

Floating rate bonds (floaters) have “adjustable” coupons that are usually tied to some variable short-term rate such as T-bill rates, although many variations exist. They differ significantly from traditional “fixed income” bonds since the coupons increase as interest rates increase and vice-versa. Therefore, they provide protection against rising interest rates and tend to trade near their par value. Government of Canada Real Return Bonds provide investors with protection against inflation by providing a real yield that is adjusted for inflation. This is achieved by pegging the face value to the rate of inflation (as measured by the Consumer Price Index), and having the coupon rate apply to the inflation-adjusted face value.

Question 19

Is the yield to call always greater than the yield to maturity?

Answer 19

Generally speaking, the yield to call will be greater than the yield to maturity when a callable bond is trading at market price that is below its call price. When the reverse is true, the yield to call will usually be less than the yield to maturity.

Question 20

What is a corporate spread?

Answer 20

Corporate spread is the required rate of return of a corporate bond minus the risk-free rate and maturity yield differential. It compensates the investor for the assumption of additional risks, which may include some or all of the following: (1) default or credit risk; (2) liquidity; and, (3) issue-specific features.

Question 21

When bonds sell above their par value, is the yield to maturity greater or less than the coupon rate?

Answer 21

The yield to maturity is less than the coupon rate.

Question 22

What is the day count convention in Canada and in the United States?

Answer 22

The day count convention in U.S. is “30/360”. The day count convention in Canada is “Actual/365.”

Question 23

Describe the relationship between bond interest rate risk and the coupon rate, the market yield, and the term to maturity.

Answer 23

The higher the coupon rate, the higher the market yield, and the lower the term to maturity, the lower the interest rate risk (duration), all else being equal

Question 24

Coupon rate, CY, YTM’

Answer 24

Coupon Rate > CY > YTM when the bond trades at a premium.
Coupon Rate = CY = YTM when the bond trades at par.
Coupon Rate < CY < YTM when the bond trades at a discount.