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FiWi > Bonds > Flashcards

Bonds Flashcards

1
Q

Which are the 3 principles applied in bond valuation?

A
  1. Money has time value
  2. Risk requires reward
  3. Market prices are generally right
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2
Q

What are bonds?

A

Type of debt or long term promissory note.

Issued by a borrower.

Promising to its holder a fixed amount of interest per year and repayment of principal at maturity

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3
Q

What are Issuers of bonds?

A

Corporations, Govs., State and local municipalities

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4
Q

What types of bonds exist?

A
  1. Debentures
  2. subordinated Debentures
  3. Mortgage Bonds
  4. Eurobonds
  5. Convertible Bonds
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5
Q

What are Debentures?

A

Are unsecured long term debt

For issuing firm: Debentures provide the benefit of not typing up property as collateral

For bondholders: More risky than secured bonds -> also higher yield

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6
Q

What are Subordinated Debentures?

A

There is a hierarchy of payout in case of insolvency

The claims of subordinated debentures are honored only after the claims of secured debt and unsubordinated debentures have been satisfied

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7
Q

What are Mortgage Bonds?

A

Secured by a lien on a property

Typically the value of the real property is greater than that of the bond issued

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8
Q

What are Eurobonds?

A

Securities issued in a country different from the one in whose currency the bond is denominated

E.g. A bond issued in Japan by an american compnay that pays interest and principal in dollar

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9
Q

What are convertible Bonds?

A

Debt securities that can be converted into stocks at a pre specific price

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10
Q

What means Seniority in Claims?

A

In the case of insolvency, claims of debts including bonds are honored before those of common or preferred stock

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11
Q

What is the par value?

A

Also known as face value. Returned to the bondholder at maturity

Usually corporate bonds have a par value of $1000

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12
Q

What is the Coupon interest rate?

A

Percentage of the par value that will be paid in form of interest.

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13
Q

What is Maturity?

A

Length of time until the bond issuer returns the par value to the bondholder and terminates the bond

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14
Q

What is Call Provision?

A

Gives company the option to redeem the bonds before maturity date.

-> have to pay bondholders a premium

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15
Q

What is an Indenture?

A

legal agreement between the firm issuing the bond and the trustee who represents the bondholder

Protects the status of bonds from being weakened by managerial actions or by other security holders

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16
Q

What are bond ratings?

A

Reflect the future risk potential of a bond.

lower rating -> higher reward

17
Q

Which factors affect bond rating?

A

Greater reliance on equity as opposed to debt in financing the firm

Profitable operations

Low variability in past earnings

Large firm size

Minimal use of subordinated debt

18
Q

What are junk bonds?

A

High risk bonds with ratings of BB or below by moody’s and Standard & Poor’s

-> High yield bonds

19
Q

What is the book value?

A

Value of an asset as shown on a firms balance sheet

20
Q

What is the liquidation value?

A

Dollar sum that could be realized if an asset would be sold individually.

21
Q

What is the market value?

A

The observed value for the asset in the marketplace

22
Q

What is the intrinsic value?

A

Also called fair value - the present value of the asset’s expected future cash flows

23
Q

What are efficient markets?

A

In an efficient market, the values of all securities fully reflect the public information

if the markets are efficient, the market value and the intrinsic value will be the equal

24
Q

What determines value?

A

Present value of its expected cashflow using the required rate of return as the discount rate

Affected by:

Amount and timing of the expected cash flows

Riskiness of the cash flows

Investors required rate of return for undertaking the investment

25
Q

What is the bond value combination?

A

C: Future expected cash flow (coupon, principal)

n: The time to maturity
r: Required rate of return

26
Q

What is Yield to Maturity?

A

Rate of return the investor will earn if the bond is held to maturity. Also known as expected rate of return

YTM = Discount rate that equates the present value of the futures cash flows with the current market price of the bond.

27
Q

How do we find YTM?

A

We need to know:

current price

time left to maturity

par Value

annual interest payment

28
Q

What is Current Yield?

A

The ratio of the interest payment to the bonds current market price.

Current Yield = Annual Interest payment / current market price of the bond

29
Q

What is Total Yield?

A

Current Yield + Capital gain or loss from bond sale

Example: Bond bought for 700$, sold for 725$

TY = 80 + (725-700)
= 105$ or 105/700
= 15%

30
Q

What is the first bond relationship?

A

Value of a bond is related to changes in the investors present required rate of return (current interest rate)

As interest increases (decreases), the value of the bond deacreases (increases)

31
Q

What is the second bond relationship?

A

Market value of a bond will be less than the par value if the investors required rate of return is above the coupons interest rate.

Bond will be valued above par value if the investors required rate of return is below the coupon interest rate

32
Q

What are discount bonds?

A

Market value of a bond will be below the par when the investors required rate is greater than the coiupon interest rate -> discount bonds

33
Q

What are premium bonds?

A

The market value of a bond will be above the par or face value when the investor’s required rate is lower than the coupon interest rate. These bonds are known as premium bonds.

If investor’s required rate of return is equal to the coupon interest rate, the bonds will trade at par.

34
Q

What is the third bond relationship?

A

long term bonds have greater interest rate than do short term bonds

A change in interest rate will have bigger impact on long term bonds

35
Q

What are the main risks for bondholders?

A

Changes in current interest rates

Default risks (bankruptcy etc.)

Call risk (if bonds are called before maturity)
Bonds are usually called when the interest rate decreases,

FiWi (4 decks)

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