CH 6 - Bond Valuation Flashcards
What is the basic structure of a bond?
The issuer (seller) agrees to pay periodic payments to the holder (buyer) in the form of coupons/interest, and repays the principal amount at the maturity date (balloon/bullet payment).
Bonds are usually issued in increments of $1,000 by default.
Define the face value
The amount of money received by the investor when the bond matures.
Used to calculate the coupon (interest) payments and the market price of the bond.
Define the coupon rate
The percentage of interest the investor will receive each year.
Used with the face value to calculate the coupon (interest) payment.
Define the yield to maturity
The annual return earned by an investor if the bond is purchased and held until maturity.
The discount rate used to determine the price of the bond.
Define the current yield
The one-year expected return on a bond purchased today
Only considers the coupon payments, not the change in value of the bond.
Define the bond price
Price that an investor will pay to purchase a bond.
Present value of all future coupon payments and the face value.
What is a cash price?
Cash price is the actual amount a buyer will pay a seller for a bond.
• Cash price includes accrued interest (accumulated interest since previous payment was
made).
o When counting days, do not include the previous coupon payment date.
Define Interest rate risk
Risk related to the relationship between bond prices and interest rates.
• Bond prices will decrease if interest rates increase.
• The price of a bond that is more sensitive will change by a larger percentage than a
bond that is less sensitive.
• The price of a bond is more sensitive when rates are decreasing than when they are
increasing.
What is a nominal return?
The rate of returned earned during the holding period based on the inflows and outflows in nominal terms (numeric).
What is the real return?
The nominal return adjusted for inflation.
What is a zero-coupon bond (pure-discount bond)?
Bond that does not pay periodic coupons and only returns the face value at maturity.
• Always issued at a significant discount to par.
• Typically compounds interest semi-annually.
• Each year the present value increases to approach the face value, this is called
implicit (or imputed) interest.
What are callable bonds?
bonds that give the issuer the right to call back the bond before maturity at a predetermined price.
• Callable bonds are generally cheaper than other bonds because they are more risky for the investor.
What are retractable bonds?
bonds that give the holder the right to sell the bond back to the issuer before maturity at a predetermined price.
What are extendible bonds?
bonds that give the holder the right to extend the bond’s maturity date.
What are convertible bonds?
bonds that give the holder the right to convert the bonds into common shares at a predetermined conversion price.
