Bonds Flashcards
Corporate bond
Could default/ company
Sovereign bond
Issued by the government- risk free
Bond def
Long term debt security
Promises to pay interest- coupons and the principle
Indenture
Agreement between borrowing company and company representing bond holders
Collateral bond
Has an asset against it
Debenture bond
Company agrees to repay and pay coupons- or risk loosing assets/ bankruptcy
Call provision
Company can repurchase/ call entire back at a set price e.g face value- difference=call premium
Restrictive covenant
Stop companies purposely defaulting
Positive restrictive covenants
Must maintain working capital above certain level
Provide statements to lenders
Negative restrictive covenant
Restriction on issueijf further debt
Bond ratings and who
Moody
Aaa- highest quality, low chance of defaulting
Issues with credit ratings- and ref
Bolton at al, 2009
Issuers payments were influencing ratings- paid moody to rate before bond launched
Barriers to entry- needed good reputation for moody to date
Controversy of credit ratings and example
Enron bankruptcy- none of 2 major credit ratings adjusted investment grade rating until 5 days before bankruptcy
Junk bond
Below bb
Low grade
Why junk bonds are controversial
Can issue more junk bonds than high grade- used to finance mergers which couldn’t traditionally be done- increased leverage and loss of jobs
Floating rate bonds
Coupon payments are variable- in line with interest rate index
Popularity depends on interest rates
Income bonds
Paid based on firms income- only if good enough- signals financial distress
Private bond types and lengths
Loans- 1-15 years
private placements- long maturity
Benefits of private bonds vs public
Easier to re negotiate after default
Don’t have to register with Sec
Cost less to distribute
CDS stands for
Credit default swap
Credit default swap
Insurance contracts to cover losses e.g bonds defaulting
Problems with cds’s
No regulation
Over inflated wealth/default
Cdo
Collaterised debt obligations
Collaterised debt obligations
Portfolio of assets sold in levels- senior, mezzanine, equity
Problems with cdo
Ratings questionable
Equity- very risky if company goes bankrupt- last in line for remaining assets
Bond price equation
Sum of coupons discounted at number of years + par value/discount of year
Sum (C/(1+r)^t) + par value/(1+r)^t
