Chapter 12 - Investing in Bonds

Question 1

Bonds

Answer 1

Long-term debt securities issued by government agencies or corporations that are collateralized by assets

Question 2

Debentures

Answer 2

long-term debt securities issued by corporations that are secured only by the corporation’s promise to pay (riskier than bonds)

Question 3

Par value

Answer 3

For a bond, its face value, or the amount returned to the investor at the maturity date when the bond is due

Question 4

Market price

Answer 4

is expressed as a percentage of the bond’s par value

Question 5

Term to maturity

Answer 5

The date at which a bond will expire and the par value of the bond, along with any remaining coupon payments, is to be paid back to the bondholder

Question 6

Call feature

Answer 6

allows the issuer to repurchase the bond from the investor before maturity

Question 7

sinking fund

Answer 7

a pool of money that is set aside by a corporation or government to repurchase a set amount of bonds in a set period of time

Question 8

Put feature

Answer 8

allows the investor to redeem the bond at its face value before it matures

Question 9

Convertible bond

Answer 9

a bond that can be converted into a stated number of shares of the issuer’s stock at a specified pricee

Question 10

extendible bond

Answer 10

a short-term bond that allows the investor to extend the maturity date of the bond

Question 11

current yield

Answer 11

the yield derived by dividing the bond’s annual coupon payments by its current market price

Question 12

yield to maturity

Answer 12

the annualized return on a bond if it is held until maturity

Question 13

yield to call

Answer 13

yield on a bond if the issue remains outstanding until its call date

Question 14

Discount bond

Answer 14

a bond that is trading at a price below its part value

Question 15

premium bond

Answer 15

a bond that is trading at a price above its par value

Question 16

term structure of interest rates

Answer 16

a graph that shows the relationship between bond yield ot maturity and time to maturity

Question 17

Liquidity preference theory

Answer 17

investors require a premium for investing in longer-term bonds

Question 18

Pure expectations theory

Answer 18

the shape of the yield curve is a reflection of the market’s expectation for future interest rate movements.

Question 19

Market segmentation theory

Answer 19

the shape of the yield curve is determined by the supply and demand of bonds for various market players in different segments of the yield curve.

Question 20

High-Yield bonds

Answer 20

bonds issued by less stable corporations that are subject to a higher degree of default risk

Question 21

T-Bills

Answer 21

short-term debt securities issued by the Canadian and provincial governments and sold at a discount

Question 22

Banker’s acceptances

Answer 22

a short-term debt securities issued by large firms that are guaranteed by a bank

Question 23

Commercial paper

Answer 23

A short-term debt security issued by large firms that is guaranteed by the issuing firm

Question 24

Default risk

Answer 24

the risk that the borrower of funds will not repay the creditors

Question 25

Risk premium

Answer 25

the extra yield required by investors to compensate for default risk; an additional return beyond the risk-free rate you could earn from an investement

Question 26

Call (prepayment) risk

Answer 26

the risk that a callable bond will be called

Question 27

inflation risk

Answer 27

the risk that the purchasing power of a bond investment will diminish due to a relative increase in inflation

Question 28

Reinvestment risk

Answer 28

the risk that the income earned from a bond cannot be reinvested at the same or a higher rate of interest as was being earned from the original bond

Question 29

Liquidity risk

Answer 29

the risk that a bond will be difficult to sell quickly without cutting the price if the investor wants to sell it.

Question 30

Interest rate risk

Answer 30

the risk that a bond’s price will decline in response to an increase in interest rates

Question 31

Interest rate strategy

Answer 31

selecting bonds based on interest rate expectations

Question 32

passive strategy

Answer 32

investing in a diversified portfolio of bonds that are held for a long period of time

Question 33

maturity matching strategy

Answer 33

selecting bonds that will generate payments to match future expenses

Question 34

List the main sources of risk for a bond

Answer 34

*Default risk
*Call (prepayment) risk
*Inflation risk
*Reinvestment risk
*Interest rate risk

Question 35

What are the different types of Bonds?

Answer 35

*Government of Canada Bonds
*Federal Crown corporation bonds
*Provincial Bonds
*Municipal Bonds
*Corporate Bonds

Question 36

Strip bonds

Answer 36

long-term debt securities issued by the Government of Canada (and some provinces), that do not offer coupon payments.