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
An investor can avoid ______ risk by purchasing noncallable bonds. In doing so the investor must accept lower ______.
- Call
2. Nominal Yields
Securities whose market value is denominated in a foreign currency, or whose interest or dividends are paid in a foreign currency, have ______ risk. It is the risk where changes in the U.S. dollar/foreign currency ______ negatively impacts the security.
- Currency
2. Exchange Rate
A Eurobond is a bond that is issued outside the U.S. and is denominated and pays interest in a foreign currency. If this currency falls against the dollar, the value of the interest payments and principal to an American investor will ______.
Decline
______ is the degree to which an asset can be quickly converted to cash.
Liquidity
______ risk is the risk that an asset cannot be sold quickly, or that selling quickly will result in a substantial loss.
Liquidity
______ securities generally have less liquidity risk than ______ securities. Liquidity risk ______ as the total quantity of a security decreases.
- Actively Traded
- Thinly Traded
- Increases
______ risk is the risk of being unable to buy or sell a security, thus sustaining a loss.
Marketability
If a security is actively traded, it has ______ marketability risk. However, if the security is thinly traded or not traded, it carries ______ marketability risk.
- Little
2. High
______ risk is similar to liquidity risk, except that ______ is not concerned with the price, only the ability to buy or sell.
Marketability
______ risk, also called ______ risk or ______ risk, is the risk that changes in law will negatively impact the value of a security.
Regulatory / Legislative / Political
Regardless of the way bonds are priced, whether they are based on dollar amount as a percentage of par or in basis points, the ______ affects the price. For example, large ______ will have preferential pricing.
- Block Size
2. Block Sizes
______ are also called dollar bonds.
Term Bonds
In a(n) ______ issue, all of the bonds are issued at once and all mature at once.
Term Bond
Term bonds are priced in points as a percentage of ______. Each point equals ______.
- Par Value
2. $10
______ are quoted as either a percentage yield or in basis points.
Serial Bonds
One basis point (BP) equals ______ of ______. For example, a 6.10% yield equals ______ basis points, or BPs.
- 1/100th
- 1%
- 610
In a(n) ______ issue, all of the bonds are issued at once. However, they mature in increments over several years. For example, a $1,000,000 bond issue might mature in $200,000 increments over 5 years.
Serial Bond
If two investors purchase bonds from the same issue with different maturity dates, they will actually have different ______ based on the number of years to ______.
- Yields
2. Maturity
The ______ is the rate which the issuing corporation has contracted to pay interest through the life of the bond. This rate never changes; the issuer will pay the rate until the bond matures and is extinguished.
Stated Rate / Nominal Yield / Coupon Rate
The ______ is calculated by dividing the annual interest by the current market value of the security rather than the face amount (or ______) of the bond.
- Current Yield
2. Par Value
An increase in the bond’s current market value results in a(n) ______ in its current yield. This is an example of the ______ relationship between price and yield.
- Decrease
2. Inverse
A bond’s ______ represents the return on investment by relating the annual coupon rate to the current price of the bond.
Current Yield
Assuming a face value of $1,000, the current yield on a 10% coupon bond priced at $900 would be ______.
11.11%
Current Yield = (Annual Interest) / (Current Market Price)
Current Yield = ($1,000 x 10%) / ($900) = 100/900 = 0.1111 = 11.11%
If a bond with a par value of $1,000 was purchased for $802, and paid a coupon rate of 5%, its current yield is ______.
6.23%
Current Yield = (Annual Interest) / (Current Market Price)
Current Yield = ($1,000 x 5%) / ($802) = 50/802 = 0.0623 = 6.23%
Bonds trading at a(n) ______ to par will have a current yield that is higher than the coupon rate.
Discount
Bonds trading at a(n) ______ to par will have a current yield that is lower than the coupon rate.
Premium
The ______, expressed as a percentage, is the total return that would be realized on a bond or other fixed income security if the bond were held until the maturity date. In other words, it is the ______ the investor will receive.
- Yield to Maturity (YTM)
2. Overall Return
Yield to maturity may be greater than the current yield (if the bond is selling at a(n) ______) or less than the current yield (if the bond is selling at a(n) ______).
- Discount
2. Premium
______ considers not only the nominal yield realized during the holding period, but also the difference (gain or loss) between the purchase price and par value received at maturity.
Yield to Maturity (YTM)
______ takes into account:
- Annual interest, or coupon payments in dollars.
- Number of years to maturity.
- Par value (or face value) realized at maturity.
- Price paid.
Yield to Maturity (YTM)
The ______ is a rate of return measuring the total performance of a bond (coupon payments as well as capital gain or loss) from the time of purchase until maturity.
Yield to Maturity (YTM)
______ = (Annual Interest + Annualized Gain OR - Annualized Loss) / [ (Purchase Price + Redemption Price) / 2 ]
Yield to Maturity (YTM)
______ evaluates the performance of a callable bond from purchase to the call date. It is the yield realized on a callable bond if the bond was redeemed by the issuer on the next available call date.
Yield to Call (YTC)
The YTC calculation uses the ______ rather than par value. This ______ is frequently at a premium price over par. In other words, the yield would be based on the ______ at the time the bond is called.
- Call Price
- Cal Price
- Call Premium
- ______: Annual interest payment paid by bond issuers.
- ______: Nominal yield or coupon rate.
- ______: Face amount of a bond.
- ______: Annual interest divided by the current market value of the bond.
- ______: Rate at which the issuer has agreed to pay interest.
- ______: Measures total performance including interest and capital gains/losses.
- ______: Measure of performance from purchase date to first call date.
- Coupon: Annual interest payment paid by bond issuers.
- Stated Rate: Nominal yield or coupon rate.
- Par Value: Face amount of a bond.
- Current Yield: Annual interest divided by the current market value of the bond.
- Nominal Yield: Rate at which the issuer has agreed to pay interest.
- Yield to Maturity: Measures total performance including interest and capital gains/losses.
- Yield to Call: Measure of performance from purchase date to first call date.
The prices of ______ bonds fluctuate more than ______ bonds when interest rates change. The ______ the maturity, the less volatile a bond is relative to current interest rate fluctuations.
- Long-Term
- Short-Term
- Shorter
Bond yields move in the ______ direction of bond prices; therefore, when a bond is selling above the par, the current yield and yield to maturity, as well as the yield to call, are ______ the nominal yield.
- Opposite
2. Below
The ______ yield is always fixed. It is the ______ determined at the time the bond is issued.
Stated Rate / Nominal Yield / Coupon Rate
Bonds are quoted in terms of ______, which represent a percentage of a bond’s par value.
Bond Points
A bond point is equal to ______ for a bond with a par value of $1,000.
$10
One point equals 1% per $100 of par value.
The last transaction in ABC 5.00s 2030 was 101. In this situation:
- ABC is the ______.
- 5.00 is the ______.
- 2030 is the ______.
- ______ is the current price.
- Bond
- Interest Rate
- Maturity Date
- $1,010 (multiply 101 by $10)
A(n) ______ equals 10 cents, or $0.10. A change of one ______ equals a change of $0.10 in the amount of interest paid on a bond with $1,000 par value.
Basis Point
A bond is quoted in ______. If a bond is quoted at 102, the price of the bond is ______.
- Bond Points
2. $1,020 (102 x $10)
If a bond is quoted at 97, it is a(n) ______ bond selling at ______, which is below its par value of $1,000.
- Discount Bond
2. $970 (97 x $10)
When quoting or sending a confirmation out to the investor, you must always quote the ______ yield between yield to maturity and yield to call.
Lowest
When a bond is at a premium, ______ is the lowest yield, which is how a premium bond would be quoted.
Yield to Call (YTC)
When a bond is at a discount, ______ is the lowest yield, current yield would be higher, ______ or “basis” is higher still, which is how a discount bond is quoted, and ______ would be highest.
- Nominal Yield
- Yield to Maturity (YTM)
- Yield to Call (YTC)
On a(n) ______ bond, the nominal yield, current yield, and yield to maturity are the same.
Par
On a(n) ______ bond, the highest yield is the yield to maturity, followed by the current yield. The nominal yield is the lowest yield.
Discount
On a(n) ______ bond, the highest yield is the nominal yield, followed by the current yield. The yield to maturity is the lowest yield.
Premium
Discount Bond:
Highest yield is \_\_\_\_\_\_ (cannot quote). Next highest is \_\_\_\_\_\_ or \_\_\_\_\_\_. Third yield is \_\_\_\_\_\_. Lowest yield is \_\_\_\_\_\_. Discount bonds MUST BE quoted to the \_\_\_\_\_\_ yield.
- CALL
- MATURITY or BASIS
- CURRENT
- NOMINAL
- MATURITY
Premium Bond:
Highest yield is \_\_\_\_\_\_. Next highest yield is \_\_\_\_\_\_. Third yield is \_\_\_\_\_\_ or \_\_\_\_\_\_. Lowest yield is \_\_\_\_\_\_. Premium bonds MUST BE quoted to the \_\_\_\_\_\_ yield.
- NOMINAL
- CURRENT
- MATURITY or BASIS
- CALL
- CALL
You must inform the investor of the worst-case scenario. When quoting yields on the trade confirmation, the broker/dealer must quote the lowest yield between ______ and ______.
- Yield to Maturity (YTM)
2. Yield to Call (YTC)
______ (______) is the measure of the current net market yields on a mutual fund’s investment portfolio.
- Standardized Yield (SEC Yield)
Standardized yield (SEC yield) is based on the ______ for the ______ period ending on the last day of the previous month divided by the highest ______ on that last day.
- Net Investment Income
- 30-Day
- Offering Price
Interest is paid for the 6-month period ______ the interest payment date.
Before
When a bond is sold somewhere in the middle of the 6-month period, the seller has earned the first portion of the interest and the new buyer will earn the remainder. This results in a(n) ______, also called a(n) ______.
- Irregular Coupon
2. Odd First Coupon
When a bond is purchased, the byer pays for the bonds, plus the ______. The seller receives the price of the bonds, plus the ______. It is important to remember that ______ is added to both the buyer’s and seller’s confirmation.
Accrued Interest
Corporate, municipal, and government agency bonds calculate accrued interest using every month having ______ and every year having ______. Regular way settlement for these bonds is ______.
- 30 Days
- 360 Days
- T+2
Government notes and bonds calculate accrued interest using every month having ______ and every year having ______. Regular way settlement for government notes and bonds is ______.
- Actual Days
- Actual Days
- T+1
When calculating accrued interest, the accrual period is from the last ______ date up to but not including the ______ date.
- Interest Payment
2. Settlement
If ______, the issuer of the bonds has transferred title to specific assets to the custody of the trustee. In order words, the bond is backed by the pledge of collateral, a mortgage, or other lien.
Secured
______ bonds have priority in the event of liquidation over all other claimants, excepting the IRS and employees’ wages.
Secured
The most common assets backing secured bonds are ______ through ______, ______ owned and operated by the issuer, and ______, as in collateral trust certificates.
- Real Estate
- Mortgages
- Equipment
- Securities
______ bonds (most common type of secured bonds) are collateralized by a lien or mortgage against real property. Corporations issue both first and second ______ bonds, with the first-______ holders retaining a senior position with respect to a claim on assets in the event of a foreclosure or liquidation.
Mortgage
______ bonds can be issued as either open-end or closed-end.
Mortgage
A(n) ______ bond allows the corporation to issue subsequent bonds secured by the same property at a later time. ______ bonds specify the maximum indebtedness the corporation can issue against the same lien. ______ bonds offer the investor greater protection.
- Open-End
- Closed-End
- Closed-End
The ______ will specify if the secured bonds are open-end or closed-end. It is a contract between the issuer and the trustee, who acts on behalf of the bondholders.
Bond Trust Indenture
In a(n) ______ bond indenture, the new bonds have equal status with the original bonds. In other words, new bonds have equal claim, or parity of title, to the collateral.
Open-End
A(n) ______ bond indenture potentially reduces the safety of the original bonds, since more bonds have claim to the same collateral. Frequently, a requirement must be met before additional bonds may be issued.
Open-End
A(n) ______ bond indenture requires that if additional bonds are issued, they must be subordinate in collateral claim status to the original bonds.
Closed-End
Investors prefer bond indentures with a(n) ______ clause.
Closed-End
______ are usually issued by railroads and airlines, and are secured by railroad cars and airplanes. Historically, these have proven to be secure investments because the bonds are retired at a faster rate than the equipment is depreciated.
Equipment Trust Certificates
With equipment trust certificates, it is the ______ who owns and operates the equipment, not the equipment ______.
- Issuer
2. Manufacturer
American Airlines might issue ______ and use airplanes as collateral. This collateral is sometimes called “______,” meaning major movable equipment.
- Equipment Trust Certificates
2. Rolling Stock
______ are backed by the securities of a different issuer. For example, suppose Dell Computer owns several shares of Intel stock. If dell issued a(n) ______, it might use the Intel stock to secure the bond. If Dell defaulted on its ______, the Intel would be sold to satisfy the bondholders’ claim.
Collateral Trust Certificate(s)
Of all secured corporate debt, ______ are considered the most senior.
First Mortgage Bonds
______ or ______, the most common type of unsecured debt, are backed only by the full faith and credit of the issuer; there is no specific collateral backing.
- Debentures
2. Unsecured Corporate Bonds
Because ______ are not backed by specific collateral, they carry more risk than secured bonds. Consequently, they generally pay a higher ______ than a secured bond from the same issuer.
- Debentures
2. Coupon Rate
Well-established corporations usually issue ______.
Debentures
In the event of default, the claims of debenture holders are ______ to those of secured bondholders but take ______ over those of stockholders.
- Subordinate
2. Priority
______ are junior in claim to all other bonds and are the riskiest bond on a corporation’s balance sheet. Consequently, a(n) ______ will have a(n) ______ yield than a debenture from the same issuer.
- Subordinated Debentures
- Subordinated Debenture
- Higher
A(n) ______, like all bonds, is backed by the faith and credit of the issuer. It has also been “cosigned” by another entity, usually a parent or affiliate. It is more attractive than a regular debenture, and therefore is more marketable.
Guaranteed Bond
Guaranteed bonds generally have a(n) ______ nominal rate than other debentures.
Lower
A(n) ______ is not a secured bond; it is not backed by collateral. Rather, it is backed by two promises rather than one.
Guaranteed Bond
A(n) ______ is convertible into common stock of the issuer at the bondholder’s discretion. Conversion is optional, and the investor may choose never to convert.
Convertible Bond
The ______ is attractive to investors, who experience the best of two worlds: they currently have the safety of the bond, but if the underlying common stock rises significantly in the future, they can convert into the common stock and benefit from that future price appreciation.
Conversion Privilege
Since ______ can convert into the common stock, their price is affected by the price of the stock. If the price of the common stock rises, the ______ price will rise proportionately and vice versa.
Convertible Bond(s)
The convertible bond will have a(n) ______, which never changes, regardless of the fluctuating price of the stock.
Conversion Ratio
Number of Common Shares at Convertible Bond Conversion = ( ______ ) / ( ______ )
- Par Value
2. Conversion Price
Assume a 6%, 10-year bond can convert into the issuer’s common stock at $40 per share. How many shares of common stock will the owner have after conversion?
25 Shares
# Shares = Par Value / Conversion Price # Shares = $1,000 / $40 = 25 shares
A(n) ______, or ______, has an initial nominal rate which later increases, or “______” to a prespecified higher rate. These are typically corporate bonds, however, certain government agencies also issue them.
- Step-Up Bond
- Step Coupon Bond
- Steps Up
A bond could either have a(n) ______ coupon or interest rate, that will not change for the life of the bond and determines the income the investor will receive from the bond, or a(n) ______ rate which will fluctuate based on an index, such as LIBOR.
- Fixed
- Variable
The London Interbank Offered Rate (LIBOR) is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans.
A(n) ______ is the product of a debt renegotiation or a bankruptcy proceeding. When a corporation can no longer honor the terms of a bond issue, it will often renegotiate the terms of the issue with bondholders. The resulting bond is called a(n) ______, or ______.
- Income Bond
- Income Bond
- Adjustment Bond
A(n) ______ no longer pays semiannual interest, and won’t unless the issuer returns to a profitable position. Therefore, it trades without ______. These bonds are very speculative, and may not return 100% of principal at maturity.
- Income Bond
2. Accrued Interest
Income bonds are only suitable for ______ investors.
Very Aggressive
______, also known as ______ or simply ______, are considered very safe investments because they are backed by the full faith and credit of the United States government.
- U.S. Government Securities
- Treasury Securities
- Treasuries
Treasuries are highly ______; there is a vast ______ for Treasuries, with high daily trading volume and numerous investors worldwide.
- Liquid
2. Secondary Market
Interest on Treasury Securities is subject to ______ taxation only, not to ______ and ______ tax. However, just like all other bonds, ______ realized from trading Treasuries are fully taxable.
- Federal
- State and Local
- Capital Gains
The U.S. Treasury issues both ______ and ______ debt instruments.
- Marketable
2. Non-Marketable
______ securities do not trade in the secondary market and may only be redeemed by the issuer. These include stable, low-risk savings bonds, known as series bonds, and include Series EE (Which replaced Series E) and Series I, which are currently sold by the U.S. Treasury.
Nonmarketable
Series bonds must be ______ by the Treasury either through banks, or electronically if purchased a(n) ______ account online, which is an online platform that facilitates the electronic purchase and sale of U.S. Treasury securities.
- Redeemed
2. TreasuryDirect
______ securities can be traded for value in the secondary market. These include Treasury bills, notes, and bonds.
Marketable
All securities issues by the Treasury Department are issued in ______, meaning they exist only as electronic records in computers without physical certificates of ownership.
Book-Entry Form
The three marketable Treasury securities are ______, ______, and ______.
- Treasury Bills
- Treasury Notes
- Treasury Bonds
Treasury bills, or T-Bills, have the shortest maturity, a maximum of ______.
T-Notes have maturities between ______ and ______.
T-Bonds have maturities greater than ______.
- 1 Year
- 2 and 10 Years
- 10 Years
T-bills are ______ instruments, or ______. They do not have a stated interest rate and they do not pay semiannual interest. They are simply bought at a(n) ______ from par and then they mature at par. The difference between purchase price and par at maturity is the investor’s ______.
- Original Issue Discount
- OIDs
- Discount
- Interest
Treasury bills are quoted on a(n) ______, which means the quote is a discount from par value. Because the bid is a larger discount from par than the ask, a T-Bill’s published bid appears ______ than the published ask, which is a smaller discount from par than is the ask.
- Discount Yield Basis
2. Larger
