Chapter 15 Flashcards
What is a bond?
corporation’s written pledge to repay a specific amount of money, with interest
What is the bond’s maturity date?
date at which the face value (usually $1,000) will be repaid
Bondholders receive interest payments every
six months at the stated interest rate (coupon rate)
What is a bond indenture?
describes legal conditions surrounding bond
Define trustee.
financially independent firm that acts as the bondholder’s representative.
Why do corporations issue bonds? (5)
improve financial leverage, increasing ROI; when it’s difficult to sell stock; interest paid to bondholders is tax-deductible business expense; bonds must be repaid and interest is mandatory; superior claim to assets over stockholders
Describe a debenture bond.
unsecured; backed only by reputation of issuing company
Most corporate bonds are what kind of bond?
debenture bond
What are the five types of bonds?
debenture bond; mortgage bond; subordinated debenture bond; convertible bond; high yield bond
Describe a mortgage bond.
corporate bond that is secured by various assets of the issuing firm, usually real estate;
Why is a mortgage bond’s interest rate lower?
because it is secured by collateral and corporate assets
Describe a subordinated debenture bond. (2)
unsecured bond that gives bondholders a claim secondary to that of mortgage or debenture bond holders with respect to interest payments and claim on assets; more risk to investor, so higher coupon rate
Describe a convertible bond.
kind of corporate bond that can be exchanged (at owner’s option) for a specified number of shares of the corporation’s common stock
What are some features of a convertible bond? (3)
lower interest rate coupon; attracts more investors, yet most don’t convert; if converted, corporation does not have to repay bond at maturity
Describe a high yield bond.
bond that pays a higher rate of interest but has a higher risk of default.
What is another name for a high yield bond?
junk bond
Describe the call feature of bonds. (2)
corporation can call in or buy back outstanding bonds from bondholders before maturity; most firms agree to not call back bonds for first 5-10 years
Under what circumstances would a bond be called back?
if their coupon rate is much higher than the going market rate
(T/F) Most corporate bonds are not callable.
False, most of them ARE callable
Is the coupon rate higher or lower for callable bonds?
higher, because of call risk
Define sinking fund.
fund with money deposited annually or semiannually that is used to pay off bondholders when bond issue comes up
Define serial bond.
bonds of a single issue that mature on different dates
Investors receive bond interest every
6 months
The annual interest generated by a bond is computed by
multiplying interest rate by face value of bond
Describe registered bonds.
registered in owner’s name
Describe registered coupon bonds.
registered owner collects principal, but anyone with coupon can collect interest
Describe bearer bonds.
person in physical possession collects (no longer issued in USA)
Describe zero-coupon bonds.
bonds sold at deep discount; makes zero coupon payments and is redeemed for face value at maturity
What is the formula for approximate market value of a bond?
($ annual interest) / (comparable interest rate)
What commission is typically made on the sale of a $1,000 bond?
$5-$35
(T/F) Interest and capital gains cannot be taxed in the context of bonds.
False, they can be taxed.
Describe bond taxation at the federal level on bonds.
no state or local income tax on the interest
Describe bond taxation at the state level on bonds.
usually only federal tax
Describe bond taxation at the municipal level on bonds.
no tax at any level
Describe Treasury Bills (T-Bills). (3)
$100 minimum @ $100 increments; 4/13/26/52 weeks to mature; sold at discount
Describe Treasury Notes (T-Notes). (3)
$100 units like T-Bills; 2/3/5/7/10 year terms; interest paid every 6 months
Describe Treasury Bonds.
$100 units like T-Bills; 20-30 year maturity; interest rates higher than T-Bills or T-Notes; interest paid every 6 months; held at maturity or sold before maturity
Describe Treasury Inflation-Protected Securities (TIPS).
$100 units like T-Bills; 5/10/30 year terms; value based on CPI (when CPI rises, principal adjusts upward); interest paid every 6 months; held at maturity or sold before maturity
Fannie Mae is short for
Federal National Mortgage Association
Ginnie Mae is short for
Government National Mortgage Association
Freddie Mac is short for
Federal Home Loan Mortgage Corporation
Describe the features of federal agency debt loans.
higher risk than Treasury securities, so higher interest rates paid; 1-30 years with 12 year average duration; minimum denominations between $5,000 and $25,000; agency debt is callable before maturity
Municipal bonds are issued by
state/local government
Define general obligation bonds.
backed by state or local government that issues them
Define revenue bonds.
repaid from money generated by the project the funds finance, such as a toll bridge
Are municipal bonds callable?
maybe, but usually not until after the first 5 or 10 years
Is the yield higher with municipal bonds?
yes, because interest earned may be exempt from federal income tax
What is the formula for taxable equivalent yield in municipal bonds?
(tax-exempt yield) / (1.0 - MTR)
What does the rearrangement of the tax equivalent yield equation give you?
a formula to calculate after tax yield: tax-exempt yield = (tax equivalent yield) * (1.0 - your MTR)
Bond ratings provide
quality and risk associated with bond issues
Bond ratings range from
AAA to D, with AAA being the best
Define bond yield.
rate of return earned by an investor who holds a bond for a stated period
current yield on corporate bond =
annual income amount / current market value
yield-to-maturity =
write out Chapter 15, Slide 26
