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Intermediate Finance > Chapter 4 > Flashcards

Chapter 4 Flashcards

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1
Q

What is a bond

A

long term contract under which a borrower agrees to make payments of interest and principal on specific dates to the holder of the bond

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2
Q

What are the main types of bonds

A

treasury bonds
corporate bonds
municipal bonds
foreign bonds

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3
Q

what is the charactaristic of a treasury bond

A

no default risk

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4
Q

what is the characteristic of a corporate bond

A

default risk

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5
Q

what is the characteristic of a municipal bond

A

interest is tax expemt

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6
Q

what is the characteristic of a foreign bond

A

additional risk

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7
Q

what is the coupon interest rate of a bond

A

coupon payment/par value

rate X FV = pmt’s

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8
Q

What is the bonds required rate of return (rd)

A

the discount rate used to calculate the PV of the bonds cash flow… also called yeild

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9
Q

what is the difference between coupon rate and rd

A

rd will fluctuate but coupon is a fixed rate

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10
Q

How do you calculate the value of a bond

A

PV of all future cash flows

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11
Q

when Rd rises above the coupon rate what happens to the bond

A

the value of the bond falls below par… leads to discounted bond

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12
Q

a bond that has just been issued is known as a…

A

new issue (for about a month)

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13
Q

once the bond has been on the market for a while then what is it called?

A

outstanding/seasoned bond

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14
Q

As a bond (premium/discount) gets closer to maturity it gets closer to what

A

bond value

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15
Q

for semi annual bonds how do the inputs change

A

divide rate by 2
multiply n by 2
divide payments by 2

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16
Q

What are provisions to Call bond

A
  • issuer can call the bond for redemption if rates go bad - good for issuer bad for the investors

bonds are more expensive since it is worse for the borrower

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17
Q

what is a call premium

A

if the bonds are called the company must pay the holder an amount greater than par value

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18
Q

what is a deferred call?

A

bond cannot be called until several years after the bond is issued

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19
Q

Provisions to Redeem Bonds

A

bonds that are redeemable at par at the holders option protect the holder against a rise in interest rate

if interest rates rise the holder will turn in bonds and reinvest proceeds at a higher rate

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20
Q

what is a sinking fund

A

provisions to pay off loan over time rather than all at maturity

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21
Q

how does. a sinking fund benefit investors

A

reduces their risk and shortens maturity

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22
Q

what are the two ways sinking funds are generally handled

A
  • call a certain percentage at par (if interest rates are below coupon and bond sells at a premium)
  • buy bond on open market (if interest rates are above coupon and bond is at a discount)
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23
Q

what is a convertible bond

A

owners can convert bond to fixed number of common stock shares

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24
Q

what is a warrant

A

option that permits the holder to buy stock at a fixed price

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25
Q

what is an income bond

A

required to pay interest only if earnings are high enough to cover interest expense

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26
Q

what is an indexed bond

A

the interest payments and maturity payments rise automatically when the inflation rises

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27
Q

do bond yeilds vary from day to day?

A

yes

28
Q

what ways can a bond yield be calculated?

A
  • yield to maturity
  • current yield
  • yield to call
29
Q

What is YTM

A

the rate earned on a bond if you hold it until maturity

  • equals expected return on if probability of default is zero and the bond cannot be called
30
Q

what function do you use to solve YTM

A

RATE

31
Q

What is the current yeild calculation

A

current yield = (annual coupon pmt/ current price)

32
Q

what is the YTM basic calculation

A

current yield + capital gains yield

33
Q

what information does the current yield provide

A

cash income a bond will generate in the current year

34
Q

what is capital gain yields equation

A

Cap gain yield = YTM - current yield

35
Q

what does capital gains yield represent

A

rate of return due to the price change

36
Q

when is a callable bond likely to be called?

A

when the interest rates are well below an outstanding bonds coupon rate

37
Q

how do you estimate a callable bonds rate

A

the yield to call rate (YTC)

38
Q

what is N and FV in the YTC

A

n is the time until company is allowed to call bond

FV is the price company must pay in order to call bond

39
Q

if you bought a bond would you be more likely to earn YTM or YTC

A

investors should except a call, therefore expected return should be YTC

40
Q

what determines the markets interest rate?

A

Rd equation

41
Q

what is r*

A

the interest rate that would exist on a riskless security if no inflation were expected

-rate on US treasury securities in an inflation-free world

42
Q

What is an inflation premium

A

the average inflation rate expected over the life of the security compensates investors for the expected loss of purchasing power

43
Q

what does treasury bill interest rate equal

A

risk free rate

44
Q

what do we use in general to estimate the short term risk free rate

A

T-bills

45
Q

what do we use in general to estimate the long term risk free rate

A

t-bonds

46
Q

What is the Maturity Risk Premium

A

The net of the interest rate risk and reinvestment risk

47
Q

what is interest rate risk

A

long term securities are more price sensitive to interest rate changes than short term securities

48
Q

what affect interest rate risk

A

length of security as well as size of coupon pmts

49
Q

what does rising rd lead to

A

bond prices to fall. “have to pay higher interest to holders so they get less from actual bond”

50
Q

what is the reinvestment rate risk?

A

short term bills are exposed to reinvestment rate risk

  • risk that funds will have to be reinvested in the future at lower rates, reducing income
51
Q

Maturity Risk Premium characteristics of long term bonds

A

high interest rate risks and low reinvestment rate risk

52
Q

Maturity Risk Premium characteristics of short term bonds

A

low interest rate risks, high reinvestment risks

53
Q

is MRP more affected by interest rate risk or reinvestment rate risk

A

interest rate risk - long term bonds usually have greater yeilds

54
Q

What is default risk premium

A

compensates investors for the risk that a borrower will default and hence not pay the interest or principal

55
Q

the greater the default risk the…

A

higher the bonds yield to maturity

56
Q

bond indenture

A

a legal document that spells out the rights of both bondholders and the issuing corporation

57
Q

what is a trustee

A

an official who represents the bond-holders and makes
sure the terms of the indenture are carried out.

58
Q

can the terms of a bond contract affect default risk

A

yes

59
Q

what is a mortgage bond?

A

a corporation pledges certain assets as security

60
Q

what is a debenture

A

unsecured bond. their holder are creditors whose claims are protected by property not otherwise pledged

61
Q

subordinated debentures

A

in the event of bankruptcy, only have claims on assets after senior debtors has been paid off

62
Q

What factors affect default risk and bond ratings?

A
  • Financial rations
    -Bond contract terms
63
Q

What is a liquidity premium

A

a liquid asset can be converted to cash quickly and at fair market value”

(small company bonds tend to have a higher liquidity premium than large company bonds)

64
Q

What is structure yield curve

A

the relationship between interest rates (or yields) and maturities

65
Q

what does the “normal” yield curve look like

A

upward sloping

66
Q

what does a downward sloping yield curve signify

A

investors expect inflation to decrease

67
Q

What are Junk bonds

A

high risk, high-yield bonds

Intermediate Finance (15 decks)

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