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FIN2303 > Chapter 13: Investing in Bonds > Flashcards

Chapter 13: Investing in Bonds Flashcards

1
Q

Bonds:

A

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

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2
Q

Par value:

A

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

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3
Q

Debentures:

A

long-term debt securities issued by corporations that are secured only by the corporation’s promise to pay

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4
Q

Term to maturity:

A

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

Bonds maturities may vary between 1 and 30 years

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5
Q

background on bonds

A

Investors provide the issuers of bonds with funds
Issuers are obligated to make interest payments and to pay the par value at maturity
Coupon payments are normally paid semi-annually
Some bonds are issued at a price below par value

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6
Q

Call Feature

A

a feature on a bond that allows the issuer to repurchase the bond from the investor before maturity
-Offer a slightly higher return than similar bonds without a call feature

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7
Q

Sinking fund

A

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
-Acts like a mandatory call feature

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8
Q

Convertible bond:

A

: a bond that can be converted into a stated number of shares of the issuer’s stock at a specified price
-Tend to offer a lower return than non-convertible bonds

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9
Q

Extendible bond:

A

a short-term bond that allows the investor to extend the maturity date of the bond
-Tend to offer a lower return than non-extendible bonds

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10
Q

Put feature:

A

a feature on a bond that allows the investor to redeem the bond at its face value before it matures
-Slightly lower return than similar bonds without a put feature

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11
Q

Bond Characteristics

A
  • call feature
  • sinking fund
  • convertible feature
  • extendible feature
  • put feature
  • yield to maturity
  • discount
  • premium
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12
Q

Yield to maturity

A

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

-If a bond sells at par value, its yield to maturity equals the coupon rate

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13
Q

Discount:

A

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

-If a bond sells below par value, its yield to maturity would exceed the coupon rate

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14
Q

Premium:

A

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

-If a bond sells above par value, its yield to maturity would be less than the coupon rate

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15
Q

Bonds Trading in the Secondary Market

A
  • Investors can sell their bonds to other investors before the bonds reach maturity
  • Bond prices change in response to interest rate movements and other factors
  • Investors buy or sell bonds from a brokerage firm’ bond inventory
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16
Q

Term structure of interest rates:

A

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

- Resulting curve is known as a yield curve
- Shape of the yield curve reflects the market’s sentiment about the direction for interest rates over time
- Yield curve shapes include normal, steep, inverted, and flat
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17
Q

Theories that attempt to explain why the term structure of interest rates is shaped the way that it is:

A

Liquidity preference theory

pure expectations theory

market segmentation theory

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18
Q

Liquidity preference theory

A

suggests that investors require a premium for investing in longer-term bonds

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19
Q

pure expectations theory

A

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

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20
Q

market segmentation theory

A

suggests that 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

21
Q

Types of Bonds

A 
Government of Canada Bonds
Federal Crown Corporation Bonds
Provincial Bonds
Municipal Bonds
corporate bonds
22
Q

Government of Canada Bonds

A

debt securities issued by the Canadian government
-Not exposed to the risk of default by the issuer
-Issued with a term to maturity of between 1 and 30 years
-Interest is paid semi-annually
-
-Can be sold easily in the secondary market
-marketable bonds –> Government of Canada bonds that can be sold in a secondary market

23
Q

Federal Crown Corporation Bonds

A
  • -debt securities issued by corporations established by the federal government
  • -Not exposed to the risk of default by the issuer
  • -Issued with a term to maturity of between 2 and 10 years
  • -Interest is paid semi-annually
  • -Can be sold easily in the secondary market
24
Q

Provincial Bonds

A

-debt securities issued by the various provincial governments

  • Risk of default by the issuer will differ depending on the province from which you purchased the bond
  • Issued with a term to maturity of between 1 and 30 years
  • Interest is paid semi-annually
  • Can be sold easily in the secondary market
25
Municipal Bonds
---long-term debt securities issued by local government agencies - Provide the funds necessary for municipal projects - Very low default risk - Uncommon investments in Canada - Terms and condition will vary with the needs of the municipality
26
Corporate Bonds
long-term debt securities issued by large firms - Subject to default risk - High-yield bonds - terms and condition will vary with the needs of the corporation
27
High-yield bonds:
bonds issue by less stable corporations that are subject to a higher degree of default risk
28
Other Fixed-Income Products
Short-Term -Debt Securities -T-Bill's -Banker's aceptances (BAs)- - Commercial Paper -
29
T-Bills:
short-term debt securities issued by the Canadian and provincial governments and sold at a discount -Do not make coupon payments
30
Banker’s acceptances (BAs):
short-term debt securities issued by large firms that are guaranteed by a bank
31
Commercial paper:
a short-term debt security issued by large firms that is guaranteed by the issuing firm
32
Canada Savings Bonds (CSBs):
ten-year debt securities issued by the Canadian government Fully guaranteed Can be purchased as a simple interest bond or a compound interest bond Can be redeemed at any time before maturity
33
Mortgage backed securities (MBSs):
represent a pool of CMHC-insured residential mortgages that are issued by banks and other financial institutions ``` A guaranteed flow-through investment Attractive to investors seeking income Can be sold in the secondary market Issued with a term to maturity of between 1 and 10 years Subject to prepayment risk ```
34
Strip Bonds
long-term debt securities issued by the Government of Canada (and some provinces) that do not offer coupon payments Can be sold at a very deep discount Although not paid, interest must be recognized every year Very safe investment in terms of default risk and can be sold in the secondary market Very high interest rate risk
35
Real Return Bonds
long-term debt securities issued by the Government of Canada that protect you from inflation risk All other bonds are exposed to inflation risk The par value of the bond is adjusted for changes in the inflation rate Coupon payments will increase with each increase in the face value
36
Return from Investing in Bonds
Your return from investing in a bond depends on the price at the time you sell it If the bond coupon rate is less than the current coupon rate on similar bonds, you must sell the bond at a discount If the bond coupon rate is more than the current coupon rate on similar bonds, you can sell the bond for a premium
37
Default Risk
Investors do not receive all of the coupon payments they are owed and may not receive all or any of the principal they are owed
38
Risk premium:
the extra yield required by investors to compensate for default risk
39
Default risk:
the risk that the borrower of funds will not repay the creditors
40
Call (prepayment) risk:
the risk that a callable bond will be called
41
Inflation risk:
the risk that the purchasing power of a bond investment will diminish due to a relative increase in inflation Inflation decreases purchasing power because it reduces the real value of your investments
42
Reinvestment Risk
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 bond
43
Interest rate risk:
the risk that a bond’s price will decline in response to an increase in interest rates
44
Impact of a Bond’s Maturity on Its Interest Rate Risk
Bonds with longer terms to maturity are more sensitive to interest rate movements
45
Selecting an Appropriate Bond Maturity
Choose maturities on bonds that reflect your expectations of future interest rates Consider investing in bonds that have a maturity that matches the time when you will need the funds
46
Interest rate strategy
selecting bonds based on interest rate expectations Expect interest rates to decline, invest heavily in long-term bonds Expect interest rates to increase, shift most of your money to bonds with short terms to maturity
47
Passive strategy
investing in a diversified portfolio of bonds that are held for a long period of time Valuable for investors who want to generate stable interest income over time and do not want to incur costs associated with frequent trading -May reflect a portfolio of bonds with diversified risk levels
48
Maturity matching strategy:
selecting bonds that will generate payments to match future expenses
49
Bond investment strategies
- interest rate strategy - passive strategy - maturity matching strategy.

FIN2303 (11 decks)

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