Ch 6 Flashcards
Face value AKA par value
Principal amount of bond that is repaid at end
Of term
Coupon
Stated interest payment made on bond
Coupon rate
Annual coupon divided by face value of bond
Maturity
Date on which principal amount of bond is paid
Yield to maturity (YTM)
Rate required in the market on bond
What happens to the present value of a bond when interest rates rise? When they fall?
The present value of the bonds cash flows decline
And the bond is worth less
Vice versa when interest rates fall
a bond that has a yield to maturity of 8% and has 10 years to maturity. What’s the present value of $1,000 paid in 10 years?
Present value of the annuity stream?
Total bond value?
Present value = $1,000/(1.08^10) = $1,000/2.1589 = $463.19
Annuity present value = $80 x (1 - 1/1.08^10)/.08 = 536.81
Total bond value = $463.19 + $536.81= $1,000
Note bond sells for exactly it’s face value
Discount bond
Bond selling for less than face value
Bond Value Equation, (numbers and verbal)
Bond value = C x [1- 1/(1 + r)^t]/r + F/(1 + r)^t
Bond value = present value. +. Present value of the
Of the coupons. Face amount
Ex. Bond value = $80 x (1 - 1/1.1^6)/.1 + $1000/1.1^6
2 main factors that determine interest rate risk?
1 the longer time to maturity
means more interest rate risk
2 the lower the coupon rate
means More interest rate risk
Current yield, ex
Bonds annual coupon divided by its price
Ex 80/955.14 = 8.38 percent
Finding the yield on a bond?
Given bond value, coupon, time to maturity and face value
Only possible to find through trial and error from equation
Below:
Bond value = C x [1- 1/(1 + r)^t]/r + F/(1 + r)^t
Indenture
Written agreement btw the corporation and lender
Detailing the terms of the debt issue
6 provisions of an indenture?
1 basic terms of the bond 2 total amount of bonds issued 3 description of property used as security 4 repayment arrangements 5 the call provisions 6 details of protective covenants
Registered form
Form of bond issue which the register of the company
Records ownership of each bond
Payment is made directly to owner of record
Bearer form
Form of bond issue where the bond is issued without
Record of owner’s name;
Payment is made to whomever holds the bond
Debenture
Unsecured debt, usually with maturity of 10 years or more
Note
Unsecured debt, usually with maturity of under 10 years
Seniority
Indicates preference in position over other lenders,
Debts are labeled as senior or junior
Sinking fund
Account managed by the bond trustee for early
Bond redemption
Call provision
Agreement giving the corporation the option to
repurchase the bond at specific price prior to maturity
Call premium
Amount by which the call price exceeds the par value of
The bond
Deferred call provision
Call provision prohibiting the company from redeeming
The bond prior to a certain date
Call protected bond
Bond that currently can’t be redeemed by issuer
Protective covenant, negative, positive?
Part of the indenture limiting certain actions that might
Be taken during the term of the loan, usually to protect
the lender
Negative = limitations Positive = requirements
Zero coupon bond
Bond that makes no coupon payments and is
Initially priced at a deep discount
floating rate bond?
Bonds where coupon rates are adjustable
Tied to 30-yr treasury bill index
Structured notes
Bonds that are based on stocks, bonds, commodities
Or currencies
Convertible bond
Can be swapped for fixed number of stock shares
Put bond
Allows holder to force issuer to buy bond back at
stated price
Bid price
Price dealer is willing to pay for a security
Asked price
Price dealer is willing to take for a security
Bid-ask spread
Difference between the bid price and the asked price
Clean price
Price of bond net of accrued interest
Price typically quoted
Dirty price AKA Invoice price
Price of bond including accrued interest
Price buyer actually pays
Real rates
Interest rates or rates of return that have been adjusted
for inflation
Nominal rates
Interest rates or rates of return that have not been adjusted
for inflation
Fisher effect, define, equation?
Relationship between nominal returns, real returns
And inflation
1 + R = (1 + r) x (1 + h)
Where R = nominal rate of return
r = real rate of return
h = inflation rate
If investors require a 10 percent real rate of return and the inflation rate is 8 percent, what must the approximate nominal rate be?
The exact nominal rate?
Approx: 10% + 8% = 18%
Exact: 1 + R = (1 + r) x (1 + h)
1.1. x. 1.08. = 1.188 or 18.8%
Term structure of interest rates AKA pure time value of money
Relationship between nominal interest rates on default-
Free, pure discount securities and time to maturity
Inflation premium
Portion of nominal interest Rae that represents
Compensation for expected future inflation rate
Interest rate risk premium
Compensation investors demand for bearing interest rate risk
Treasury yield curve
Plot of the yields on treasury notes and bonds
Relative to maturity
Default risk premium
Portion of a nominal rate or bond yield that represents
Compensation for the possibility of default
Tax ability premium
Portion of a nominal interest rate or bond yield that
Represents compensation for unfavorable tax status
Liquidity premium
Portion of a nominal interest rate or bond yield that
Represents compensation for lack of liquidity
6 main effects on a bond yield?
1 real rate of interest Premiums: 2 expected future inflation 3 interest rate risk 4 default risk 5 tax ability 6 lack of liquidity
