CF chapter 24 Flashcards
Yield of a bond
It is the rate of return implied by the price of the bond:
The yield can be interpreted as the required return from investing in the bond.
Coupon rate:
the rate of interest paid by bond issuers on the bond’s face value
Price coupon bond formula
P = C/Y * ( 1 - 1/(1+y)^T) + F /(1+y)^T
C= coupon amount in $
F = face value of debt on coupon
Leverage buyout
When a group of private investors purchase all
the equity of a public corporation and finances
the purchase primarily with debt
Prospectus
a public bond issue, similar to a stock issue
Indenture
Included in a prospectus, it is a formal contract between a bond issuer (a corporation) and a trust company
The trust company represents the
bondholders and makes sure that the terms of the indenture are enforced.
In the case of default, the trust company represents the interests of
the bond holders.
Unsecured debt
in the event of bankruptcy/liquidation, unsecured bondholders
are paid from the sale of assets of the firm that are not already pledged as
collateral on other debt
When a firm sells a callable bond:
– It is “short” a bond
– It is “long” an option to buy back the debt “before” maturity
When is the callable bond option used?
When the firm can buy the debt back at a lower than market price
This happens when the yield has increased from the issuance date
TIPS (Treasury-Inflation-Protected Securities)
When prices rise (there is inflation), the future
principal is adjusted upward
Coupons are also adjusted for inflation
An inflation-indexed bond issued by the U.S.
Treasury with maturities of 5, 10, and 20 years
They are standard fixed-rate coupon bonds with
one difference: The outstanding principal is
adjusted for inflation
Revolving line of credit
an agreement that permits an account holder to borrow money repeatedly up to a set dollar limit while repaying a portion of the current balance due in regular payments
Covenants
Restrictive clauses in a bond contract that limit the issuers from undercutting their ability to repay the bonds
E.g.
Restrict the ability of management to pay dividends
– Restrict the level of further indebtedness
– Specify that the issuer must maintain a minimum amount
of working capital
Convertible Bond
A corporate bond with a provision that gives the
bondholder an option to convert each bond
owned into a fixed number of shares of common
stock
Conversion Ratio
The number of shares received upon conversion
of a convertible bond, usually stated per $1000
of face value
