Bonds Flashcards
Bond definition
A debt instrument whereby an investor lends money to an entity that borrows funds for a defined period of time at a fixed interest rate.
Who issues bonds?
Companies or governments.
What determines the term of a bond?
1) companies choose what to issue.
2) depends on financial plans of the issuing company.
3) periods over which investors want to invest.
Why do governments issue bonds?
1) when they need to borrow money.
2) when the expenditure of government is more than the taxes collected.
Bond terms
1) redemption date - when bond needs to be repaid.
2) interest rate.
3) frequency of interest rate.
What is the nominal value of bond?
1) the amount of the loan.
2) the amount to be repaid
3) known as par value or face value.
What is the redemption date?
1) the date the loan is paid back.
2) known as the maturity date.
What is a coupon?
This is the interest rate applied to the nominal value.
What is the bond yield?
1) This is the return on the bond.
2) the yield is only the same as the coupon if the bond is purchased at the nominal value.
3) annual coupon / price.
What happens to bonds if interest rates increase?
1) The yield will have to increase to attract buyers.
2) To increase the yield the price needs to fall.
What happens to bonds if interest rates decrease?
1) Buyers will accept a lower yield.
2) To lower the yield the price will increase.
What is the relationship between bond prices and yields?
They work in opposite ways.
Advantages of investing in bonds?
1) Predictable income compared to volatile dividends from equities.
2) Agreed dates and amount of redemption.
Disadvantages of investing in bonds?
1) Issuer may fail to pay some or all of the coupons or redemption.
2) Selling a bond before maturity may lead to a different yield.
What are credit rate agencies?
Specialist company that look and bond issuers and assess the credit risk. 3 main agencies are Moody’s, Standard & Poors and Fitch Ratings.
AAA: Triple A are the highest (I.e. best) rated companies.
