CH.6- Fixed-Income Securities: Features and Types

Question 1

FIXED INCOME SECURITIES

Answer 1

debt of issuing security
-promise to pay maturity value or principal on maturity date

○ Pay interest in intervals over life of security or at maturity

Question 2

Rationale for borrowing

Answer 2

○ Finance operations or growth

Take advantage of operating leverage

Question 3

rationale for issuing fixed income securities

Answer 3

• to finance growth
• to add to or expand companies current operations or to buy other companies
• s also borrow to take advantage of operating leverage ( greater return on cash invested in their business than it would cost to borrow money)

Question 4

Bond

Answer 4

long term fixed obligation debt security that is secured by physical assets
-Pmt of regular interest pmts, return of principal on date of maturity

Question 5

Debenture

Answer 5

type of bond that promises pmt of regular interest and re-pmt of principal at maturity, may be secured by something other than physical asset (also called Unsecured Bonds)

Question 6

face vale/par value

Answer 6

principal amt bond issuer contract to pay at maturity to bond holder

Question 7

Coupon rate

Answer 7

rate at which bond issuer pays regular interest

Question 8

Maturity Date AND term to maturity

Answer 8

date at which bond matures and principal amt of loan paid back to investor holding bond

term to maturity: amt of time from beginning to maturity

Question 9

yield

Answer 9

bond yield is approx. measure of annual return on bond if held to maturity

-yield NOT SAME AS COUPON RATE

Question 10

floating rate securities

Answer 10

bonds with variable coupon rates typically referred to as Floating rate securities

Question 11

amount of interest at each pmt date

Answer 11

coupon rate / # pmts in year

Question 12

Yield and coupon rate relationship

Answer 12

○ If yield MORE than coupon rate = discount
○ If yield = coupon rate= PAR
○ If yield LESS than coupon rate= Premium

Question 13

categorizing bonds

Answer 13

Money market Up to 1 yr term to maturity

Short term bonds More than 1 -5 yr remaining to maturity

Medium term bonds 5-10 yr remaining to maturity

Long Term Bonds More than 10 yrs remaining to maturity

Question 14

liquid bonds

Answer 14

trade in significant volumes and for which it is possible to make medium and large trades quickly without making significant sacrifice on the price

Question 15

negotiable bonds

Answer 15

bonds that can be trf because they are in deliverable form
( ○ Certificates not torn, power of attorney has been signed
)

Question 16

marketable bonds

Answer 16

bonds for which there is a ready market

Question 17

Strip Bonds (zero coupon bonds)

Answer 17

when dealer acquires block of high quality bonds and separates individual future dated interest coupons from rest of bond (underlying bond residue)

• • Sells each coupon and residue separately at significant discounts to future value
• ○ Holders don’t get interest pmts- strips bought at discount price that provides compounded rate of return when they mature at par

Question 18

Callable bonds

Answer 18

bond issuers can pay off bond before maturity- to take advantage of lower interest rates, or to reduce their debt when they have excess cash

• ○ Allows issuer to call bonds for redemption at specified price on specific dates or during specific intervals over life of bond
  ○ Price usually set higher than par value of bonds– premium pmt for holder

Question 19

accrued interest

Answer 19

interest that has accumulated since the last interest payment date, belongs to holder of bond

Question 20

call protection period (on callable bonds)

Answer 20

interest that has accumulated since the last interest payment date, belongs to holder of bond

Question 21

Extendible Bonds and debentures

Answer 21

issued with short maturity term (i.e. 5yrs), with option for investor to exchg the debt for identical amt of longer term debt

• ○ Maturity date of the bond can be extended so that the bond changes from short term bond to long term bond

Question 22

retractable bonds

Answer 22

issued with long maturity term (min 10yrs), investors have right to turn in the bond foe redemption at par sooner (i.e 5 yrs), by retraction date

Question 23

why are convertible bonds issued

Answer 23

• Conversion privilege makes bond more saleable or attractive to investors
• Lowers cost of the money borrowed + enable a company to raise equity capital indirectly on terms more favourable
• § Permits holding of a 2 way security

Combines much of the safety and certainty of income earned on bond with option to convert it to C/S

• § Appeals to investors who:
  □ Wants share in company growth and avoid substantial risk
  □ Willing to accept lower yield of convertible in order to Have call on C/S

Question 24

characteristics of convertible bonds

Answer 24

○ Conversion price gradually raised over time to encourage early conversion
○ If c/s shares split, conversion privilege adjusted accordingly- protection against dilution

Question 25

SINKING FUND

Answer 25

sums of money set aside out of earnings each year to provide repayment of all or part of debt issue by maturity

Question 26

PURCHASE FUND

Answer 26

to retire at specified amount of the outstanding bonds or debentures through purchases in market

Question 27

Protective provisions (COVENANTS)

Answer 27

safeguards In the bond contract to guard against any weakening in the security holders position