Chapter 12 - The Bond Market

Question 1

Primary issuers of securities (2)

Answer 1

Governments - debt only

Corporations - equity and debt

Question 2

Capital structure

Answer 2

Choice between equity and debt.

-done to raise capital to get listed on the stock market-

Question 3

Government bonds

Answer 3

US govt bonds are considered risk free, but T-Bills are even more risk free because of short maturity.
-still inflation risk and IRR-

Question 4

Municipal bonds

Answer 4

Issued by states/cities. Not default free. They have a tax exemption!

Question 5

Types of municipal bonds (2)

Answer 5

1. Revenue bonds: backed by the cashflow of a particular project
2. General obligation bonds: do not have a specific subject. Backed by “full faith and credit” of the government.

Question 6

Agency bonds

Answer 6

Issued by government-sponsored enterprises. They buy mortgages from banks and sell insurance. They act with a guarantee that the US govt. will not let them default.

Question 7

Corporate bonds

Answer 7

Bonds issued by the largest corporations,, the default risk is significantly higher than for treasury bonds, but a lot of firm heterogeneity.

Question 8

Bond indenture

Answer 8

Contract stating lender’s rights and borrower’s obligations

Question 9

Bond Characteristics (3)

Answer 9

1. Restrictive covenants
   - bondholders place limits on what the company cand do (limit dividends, new debt, etc) more restrictive covenants = lower i
2. Call provisions
   - issuers can force bondholders to sell back bonds (callable). i is higher for a callable bond.
3. Conversion option
   - debt that can be converted to equity by holder. i is smaller for a convertible bond.

Question 10

Seniority

Answer 10

If a company defaults, bondholders are SENIOR to stockholders.
If a bond is secured everyone gets paid because of collateral.
Unsecured bonds have a higher i because they are more risky