Chapter 4: Debt Instruments Flashcards
A bond is a(n) ______. Consequently, it creates a(n) ______ for the issuer. The bond investor is the ______. Bonds are issued by ______, ______ (state and local governments and political subdivisions), and the ______.
- Debt Instrument
- Liability
- Lender
- Corporations
- Municipalities
- U.S. Government
The face amount of the bond or its par value is ______ per bond. Bonds have a stated ______ which expresses the income the investor will receive on the bond. It is always expressed as an annual percentage; however, most bonds pay every ______, or ______.
- $1,000
- Interest Rate
- 6 Months or Semiannually
Bonds are called “______” securities because of their fixed, semiannual interest payments. Because of this, bonds have limited ______ potential.
- Fixed Income
2. Growth
Bonds have priority over stock in the event of ______.
Liquidation
The relationship between an investment’s risk and its yield is called the ______, which dictates that the higher an investment’s risk, the higher its potential reward.
Risk/Reward Ratio
______ risk, also known as ______ or ______ risk, is the risk that an issuer may become unable to meet interest or principal payments on its bonds. In other words, the issuer may become ______, and forced into bankruptcy.
- Credit
- Business or Default
- Insolvent
Many factors affect an issuer’s ______ risk, such as competitive pressure, market share, profit margin, and competence of management.
Credit
______ risk is usually managed with a long-term focus.
Credit / Business / Default
______ are safer than ______ when an insolvent corporation liquidates because ______ are paid before ______.
- Bonds
- Stock
- Bonds
- Stock
Different bond issuers expose the investor to different levels of default risk. ______ debt is considered the safest category of debt. ______ debt is considered the next safest debt category. The riskiest category of debt is ______ debt.
- U.S. Government
- Municipal
- Corporate
The threat of suffering a loss due to a change in the interest rate is called ______ risk. All fixed income securities are subject to this risk. Even U.S. Treasury bonds, which have very little default risk, carry this risk.
Interest Rate
______ maturities are at greater interest rate risk than ______ maturities. Also, the ______ the bond’s stated interest rate is, the more volatile the bond.
- Longer
- Shorter
- Lower
The relationship between bond prices and interest rates is ______. As rates rise, bond prices ______. And as rates drop, bond prices ______.
- Inverse
- Drop
- Rise
______ risk, also known as ______ risk or ______ risk, is the risk that an investment’s value is negatively affected by inflation.
- Inflation
2. Purchasing Power or Constant Dollar
______ is defined as a general rise in prices and a resulting loss in the purchasing power of money. It is created by too many dollars chasing too few goods, which causes the cost of gods to rise.
Inflation
As fixed income securities, bonds are subject to ______ risk. The value of the bond’s fixed semiannual interest payments steadily ______ during inflationary periods, as does the value of the ______, which is received at maturity.
- Inflation
- Decline
- Face Amount
______ risk is the risk that in a falling interest rate environment, bond proceeds must be reinvested at lower rates, reducing the investor’s yield.
Reinvestment
An investor who wishes to eliminate reinvestment risk over the life of a bond will purchase a(n) ______, which has no stated interest rate and pays no semiannual interest. It is purchased at a large ______ from its par value, which is $1,000. At maturity, the investor receives par value from the issuer. The difference between the investor’s deeply ______ purchase price and par value received at maturity is the investor’s interest; the investor locks in a yield over the life of the bond.
- Zero-Coupon Bond
- Discount
- Discounted
Zero coupon bonds are also called ______, or ______.
Original Issue Discounts (OIDs)
______ risk is the risk that a callable bond will be redeemed by the issuer before maturity. This happens at the worst time for the bondholder: when interest rates have ______.
- Call
2. Fallen
While exercising its call privilege benefits the ______, it negatively impacts the ______. If the ______ reinvests the principal in similar bonds, the yield will be substantially lower since the interest rate has been significantly reduced.
- Issuer
- Bondholder
- Investor
Callable bonds have ______ stated, or nominal, interest rates. The investor accepts call risk in order to receive the ______ bond yield.
Higher
Issuers pay a higher interest rate for ______ bonds because they want the privilege to refinance at lower future interest rates, should they manifest. The higher interest rate is the ______ of purchasing this future refinancing right. Issuers often prepare for future calls by setting aside money for this purpose in a(n) ______.
- Callable
- Cost
- Sinking Fund
Callable bonds are callable at a price above call, which is known as the ______. This makes the call risk more palatable to bond investors.
Call Premium