Ch 6 - Bonds

Question 1

What is par value in bonds?

Answer 1

aka - face value
sum of money that the corp promises to pay at bond’s expiration
-usually also the amt the bondholder gives to the corp in the beginning

Question 2

What is coupon rate in bonds?

Answer 2

the interest rate of the bond

-aka coupon yield

Question 3

What is maturity in bonds?

Answer 3

the number of years from when bond is issued to when it expires

Question 4

what type of debt capital financing involves a fixed coupon payment at fixed intervals and payment of par value at maturity?

Answer 4

bonds

Question 5

what is bond indenture?

Answer 5

bond contract between bond issuer (corp) and bondholder (investory) and describes all of bond’s features (coupon rate, par value, maturity, covennts

Question 6

What are a bond’s covenants

Answer 6

outline things the company is obligating itself to do or not do in order to protect bondholders

Question 7

What are the two types of bond covenants?

Answer 7

affirmative (things company pledges to do)

negative (things company pledges not to do)

Question 8

How does a company stand in default of a bond?

Answer 8

by not following the stated covenants of the bond

Question 9

What is debt capital?

Answer 9

firm financings that appear in the debt section of the balance sheet

Question 10

what are the two types of cash flows from a bond?

Answer 10

1. coupon payment stream (annuity)

2. par (face) value repayment (lump sum)

Question 11

What are the two types of bond questions?

Answer 11

1. given the discount rate, find market price

2. given market price, find discount rate (aka yield to maturity)

Question 12

What is yield to maturity (YTM) or promised yield?

Answer 12

average annual rate of return that investors require to receive on a bond if held to maturity

aka - bond’s discount rate

Question 13

What are three measures of bond yield?

Answer 13

1. coupon yield coupon rate)
2. yield to maturity
3. current yield

Question 14

What happens when a bond sells at a discount?

Answer 14

the YTM will always be higher than coupon yield because investors receive coupon payments that make up coupon yield but also tie increase in price over time

Question 15

what is the inverse price-yield relationship?

Answer 15

when you buy the bond at less than face value ( a discount) and you still get a higher yield because you get paid the face value in the end plus the coupon payments

Question 16

what is duration?

Answer 16

measure of the interest rate sensitivity of a bond

Question 17

What happens if the coupon rate is greater than the discount rate?

Answer 17

the bond will sell for a premium

(the market rate is lower than the coupon pmt rate

Question 18

As market yields go up, what happens to the price of existing bonds?

Answer 18

The price of the existing bonds decreases (sells at a discount) in order to stay competitive with newly released bonds that are selling at a higher yield for same years to maturity

Question 19

As market yields (interest rates) fall, what happens to price of existing bonds?

Answer 19

The price of bonds will go up, this is because the bond can sell at a premium. The bond now pays at higher rates.

Question 20

If the coupon rate is lower than the discount rate, what happens to the selling price of the bond

Answer 20

bond sells at lower price, is discount

Question 21

If the coupon rate is higher than the discount rate, what happens to the selling price of the bond

Answer 21

the bond sells at a higher rate, a premium

Question 22

T or F – As the coupon rate increases, the bond price will increase.

Answer 22

True – Bond prices are calculated by taking the present value of the coupons and face value of bonds. If the coupons are larger, the present value of the coupons will also be larger. Therefore, price of the bond will be higher.

Question 23

T or F: A bond w/longer time to maturity will have less sensitivity to changes in interest rates.

Answer 23

False: bonds w/ longer times to maturity have more sensitivity

Question 24

T or F - Bond A has 20 yrs to maturity while bond B has 5 yrs to maturity. If interest rates increase, then price of Bond A will decrease more than price of Bond B.

Answer 24

True - bonds w/ loner times to maturity are more sensitive to changes in interest rates