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investments > Chapter 10 - bond prices and yields > Flashcards

Chapter 10 - bond prices and yields Flashcards

1
Q

bond

A

A security that obligates the issuer to make specified payments to the holder over a period of time

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2
Q

par/face value

A

The payment to the bondholder at the maturity of the bond

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3
Q

coupon rate

A

A bond’s annual interest payment per dollar of par value

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4
Q

annual bond payment =

A

= coupon rate x par value

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5
Q

indenture

A

the contract between the issuer and the bondholder

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6
Q

zero coupon bond

A

A bond paying no coupons that sells at a discount and provides only a payment of par value at maturity

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7
Q

asked yield

A

a bond’s YTM based on the asking price

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8
Q

yield to maturity (YTM)

A
  • the average rate of return to an investor who purchases the bond for the asked price and holds it until maturity
  • The discount rate that makes the present value of a bond’s payments equal to its price
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9
Q

sale/invoice price

A

the amount the buyer actually pays, equals the stated price plus the accrued interest

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10
Q

accrued interest

A

= (annual payment / 2) x (days since last payment/days separating payments)

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11
Q

bill

A

maturity of less than a year

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12
Q

notes

A

maturities from 1-10 years

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13
Q

bond

A

maturities from 10-30 years

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14
Q

call provision

A

allow the issuer to repurchase the bond at a specified call price before the maturity date

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15
Q

refunding

A

using proceeds from the new bond issue to pay for the repurchase of the existing higher-coupon bond at the call price

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16
Q

callable bond

A
  • Bond that may be repurchased by the issuer at a specified call price during the call period
  • Issued with higher coupons and promised YTM
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17
Q

deferred callable bond

A

a callable bond that has a period of call protection, an initial time during which the bonds are not callable

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18
Q

convertible bond

A
  • A bond with an option allowing the bondholder to exchange the bond for a specified number of shares of common stock in the firm
  • Offer lower coupon rates and stated/promised YTM
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19
Q

conversion ratio

A

number of shares for each bond that is exchanged

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20
Q

conversion premium

A

the excess of the bond price over its conversion value

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21
Q

put bond

A

gives the holder the right to demand the issuer pay back the principal before the bond matures, for whatever reason

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22
Q

floating rate bonds

A

Bonds with coupon rates that periodically reset according to a specified market rate

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23
Q

risk of a floating rate bond

A

if the health of the firm decreases, investors will demand a greater yield premium, and the price of the bond will fall

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24
Q

preferred stock

A

Promises to pay a specified cash flow stream to perpetuity

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25
Q

how is preferred stock different from bonds

A
  • the failure to pay the promised dividend does not result in corporate bankruptcy
  • The dividends owed simply cumulate, and the CS holders may not receive any dividends until the PS holders have been paid in full
  • Dividends on PS are not considered tax-deductible expenses
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26
Q

what is the tax rate on preferred stock dividends

A

50%

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27
Q

where is the claim on assets of a preferred stockholder in relation to bondholders and common stockholders

A

below bonds but above CS

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28
Q

floating rate preferred stock

A

dividend rate is tied to a measure of current market interest rates

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29
Q

when do preferred stockholders get some voting power

A

If preferred stock dividend is skipped, holders will then be provided some voting power

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30
Q

municipal bonds

A

issued by state and local governemnts

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31
Q

what is the tax on municipal bonds

A

tax free

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32
Q

who are the biggest issuers of municipal bonds

A

FHLBB, farm credit agencies, Ginnie Mae, Fannie Mae, and Freddie Mac issue considerable amounts of muni bonds

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33
Q

foreign bonds

A
  • issued by a borrower from a country other than the one in which the bonds are sold
  • Denominated in the currency of the country in which it is marketed
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34
Q

what type of bond is “a dollar-denominated bond issued in the US by a German firm”

A

foreign bond

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35
Q

Eurobonds

A

are denominated in one currency, usually that of the issuer, but sold in other national markets

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36
Q

what kind of bonds are “dollar-denominated bonds sold outside the US”

A

eurobond

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37
Q

inverse floaters

A
  • The coupon rate falls when the general level of interest rate rises
  • PV of each dollar falls as well as the price
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38
Q

asset-backed bonds

A

The income from a specified group of assets is used to service the debt

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39
Q

pay-in-kind bonds

A

Issuers may choose to pay interest either in cash or additional bonds

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40
Q

catastrophe bonds

A
  • A way to transfer “catastrophe risk” to the capital markets
  • Investors receive compensation in the form of higher coupon rates for taking on risk
  • But in the vent of a catastrophe, the holders will lose all or part of their investment
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41
Q

indexed bonds

A

Make payments that are tied to a general price index or the price of a particular commodity

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42
Q

nominal bond return =

A

= (interest + price appreciation) / initial price

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43
Q

real bond return =

A

= [(1 + nominal return) / (1 + inflation)] - 1

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44
Q

bond value =

A

= PV of coupons + PV of par value

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45
Q

pv factor

A

= 1 / (1 + r)^T

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46
Q

T-period annuity factor for IR = r:

A

= (1 / r) [1 - (1 / (1 + r)^T]

47
Q

Financial calculator inputs

A
  • n: number of periods till maturity
  • i: interest rate per period (as a percentage), decimal on excel
  • PV: present value (- number because purchase entails a cash outflow)
  • FV: future value or par/face value
  • PMT: amount of coupon payment
48
Q

what is the relationship between bond price and yield

A

Inverse relationship between bond prices and yields

49
Q

what is the relationship between maturity and sensitivity to changes in interest rates

A

the longer the maturity of the bond, the greater the sensitivity of it’s price to changes in the interest rate

50
Q

flat prices

A

bond prices quotes net of accrued interest, appear in the financial press

51
Q

invoice price

A

bond price quotes that include accrued interest

52
Q

Invoice price =

A

= flat price + accrued interest

53
Q

settlement date (for excel)

A

date you buy the bond

54
Q

excel function for bond price

A

=PRICE(settlement date, maturity date, annual coupon rate, YTM, redemption value as % of par value, number of coupon payments per year)

55
Q

yield to maturity function for excel

A

=YIELD(settlement date, maturity date, annual coupon rate, bond price, redemption value as % of par value, number of coupon payments per year)

56
Q

bond equivalent yield

A

annualized yield resulting in an APR

57
Q

effective annual yield

A

accounts for compound interest

58
Q

current yield

A

Annual coupon divided by bond price

59
Q

premium bonds

A
  • Bonds selling above par value
  • Coupon rate > current yield > YTM
60
Q

discount bonds

A
  • Bonds selling below par value
  • YTM > current yield > coupon rate
61
Q

Yield to call (For callable bonds)

A
  • the same as YTM except for FV = call price
  • the compound interest rate at which the present value of a bond’s future coupon payments and call price is equal to the current market price of the bond
62
Q

explain how a callable bond works

A
  • When interest rates fall, the PV of the bond’s scheduled payments rise, but the call provision allows the issuer to repurchase the bond at the call price
  • If call price < PV of the scheduled payments, the issuer can call the bond at the expense of the bondholder
  • Suggests that investors might be more interestedin a bond’s YTC than YTM
63
Q

explain how a callable bond works

A
  • When interest rates fall, the PV of the bond’s scheduled payments rise, but the call provision allows the issuer to repurchase the bond at the call price
  • If call price < PV of the scheduled payments, the issuer can call the bond at the expense of the bondholder
  • Suggests that investors might be more interested in a bond’s YTC than YTM
64
Q

when does RoR = YTM

A

if all coupons are reinvested and earn the bond’s YTM

65
Q

realized compound return

A

Compound rate of return on a bond with all coupons reinvested until maturity

66
Q

when can realized compound return be calculated

A

only after the investment period ends unless there is an accurate forecast of future interest rates

67
Q

horizon analysis

A

Analysis of bond returns over a multiyear horizon, based on forecasts of the bond’s yield to maturity and the reinvestment rate of coupons

68
Q

reinvestment rate risk

A

Uncertainty surrounding the cumulative future value of reinvested bond coupon payments

69
Q

when does a bond sell at par

A

coupon rate = market interest rate

70
Q

when does a bond sell at a premium

A

when the coupon rate > market interset rate

71
Q

happens when the coupon rate > market interest rate

A

the interest income is greater than available in the market leading investors to bid the bond price above par

72
Q

when does a bond sell at a discount

A

coupon rate < market interest rate

73
Q

what happens when coupon rate < market interest rat

A

the interest income is less than available in the market leading investors to bid the bond price below par

74
Q

what is the relationship between YTM and HPR

A

inverse relationship

75
Q

Original-issue discount (OID) bonds

A

issued at a discount to par

76
Q

STRIPS

A
  • separate trading of registered interest and principal of securities
  • Zero-coupon bonds
  • “Stripped” of their coupon payments and each payment is an independent security
77
Q

after-tax returns

A

Additional gains/losses from changes in market interest rates are treated as capital gains/losses of the OID bond sold during the tax year

78
Q

what are the rating agencies

A

Moody’s, S&P, and Fitch

79
Q

investment grade bonds

A

bonds rated BBB and above by Standard & Poor’s or Baa and above by Moody’s

80
Q

speculative grade/junk/high yield bonds

A

bonds rated BB or lower by Standard & Poor’s, Ba or lower by Moody’s, or unrated

81
Q

what is an advantage of issuing speculative grade/junk/high yield bonds

A

Lower-cost financing alternative than borrowing from banks

82
Q

coverage ratios

A

company earnings to fixed costs

83
Q

Times-interest-earned ratio

A

EBIT

84
Q

Fixed-charge coverage ratio

A

ratio of earnings to all fixed-cash obligations

85
Q

how can coverage ratios signal possible cash flow difficulties

A

low/falling coverage ratios signal possible cash flow difficulties

86
Q

what can leverage ratios indicate

A
  • excessive indebtedness
  • will the firm earn enough to satisfy the obligations to its bonds?
87
Q

current ratio

A

current assets/current liabilities

88
Q

quick ratio

A

current assets excluding inventories/current liabilities

89
Q

what do liquidity ratios measure

A

Measures the ability to raise cash from its most liquid assets

90
Q

what do profitability ratios do

A

measure a firm’s overall performance

91
Q

ROA

A

EBIT/total assets

92
Q

ROE

A

NI/equity

93
Q

what does a high profitability ratio indicate

A

should be better able to raise money in security markets

94
Q

what are some profitability ratios

A
  • ROE
  • ROA
95
Q

what are some coverage ratios

A
  • Times-interest-earned ratio
  • Fixed-charge coverage ratio
96
Q

what is an example of a leverage ratio

A

debt/equity

97
Q

what are some liquidity ratios

A
  • current ratio
  • quick ratio
98
Q

sinking fund

A

A bond indenture that calls for the issuer to periodically repurchase some proportion of the outstanding bonds prior to maturity

99
Q

details of a sinking fund purchase

A
  • repurchase a fraction of the outstanding bonds in the open market each year
  • at a special call price
  • Option to purchase the bonds at the MP or sinking fund price (whichever is lower)
  • Call price usually set at par value
100
Q

serial bond

A

has staggered maturity dates

101
Q

subordination clause

A

Restrictions on additional borrowing that stipulate that senior bondholders will be paid first in the event of bankruptcy

102
Q

collateral on a bond

A

A specific asset pledged against possible default on a bond

103
Q

mortgage bond

A

collateral is property

104
Q

debenture bond

A

bond not backed by specific collateral

105
Q

Default premium (credit spread)

A
  • The increment to promised yield that compensates the investor for default risk
  • Difference between the promised yield on a corporate bond and the yield of an otherwise identical government bond that is riskless in terms of default
106
Q

credit default swaps (CDS)

A

An insurance policy on the default risk of a corporate bond or loan

107
Q

yield curve

A

A graph of yield to maturity as a function of the term to maturity

108
Q

Term structure of interest rate

A

The relationship between yields to maturity and terms to maturity across bonds

109
Q

spot rate

A

The yield to maturity on a zero-coupon bond of a given maturity

110
Q

expectations theory

A

The theory that yields to maturity are determined solely by expectations of future short-term interest rates

111
Q

forward rate

A
  • The theory that yields to maturity are determined solely by expectations of future short-term interest rates
  • (1 + Yn)^n = (1 + Y(n-1))^(n-1) x (1 + Fn)
112
Q

liquidity theory

A

The theory that investors demand a risk premium on long-term bonds

113
Q

liquidity premium

A
  • The yield spread demanded by investors as compensation for the greater risk of longer-term bonds
  • F = E(r) + liquidity premium

investments (14 decks)

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