Chapter 5: Bonds Flashcards
What is a bond?
A bond is a debt instrument whereby an investor lends money to an entity (Such as a company or government) that borrows the money for a defined period of time at a fixed rate of interest.
What are the three major ways to raise finance?
1) Bonds
2) Bank Loans
3) Equity Issues
Who are the two major issuers of bonds?
Two major issuers of bonds:
1) Companies - issuing corporate bonds
2) Governments - issuing government bonds
What drives the interest rates payable on bonds?
Different interest rates payable on bonds are driven by the returns demanded by investors for bonds with different repayment dates.
Required rates of interest increase as the time to repayment increases.
Longer dated bonds are more risk and therefore investors want greater returns.
Give the three key features of bonds.
1) Repayment Date - When the money will be returned.
2) Tradeable - Bonds can be sold before they reach their repayment date.
3) Interest rate and frequency - Percentage paid as interest and how often it is paid.
What is the nominal value of a bond?
Give two other possible names for the nominal value of a bond.
The nominal value of a bond is the amount to be repaid on the repayment date.
1) Par value
2) Face value
Give two other possible names for the repayment date of a bond.
1) Maturity date
2) Redemption date
What is the coupon on a bond?
The coupon is the interest rate applied to the nominal value.
What is a bond yield?
Yield is another word for return and it is expressed as an annual percentage.
Explain the relationship between interest rates and bond yields.
If interest rates rise, to sell a bond, the yield will have to increase to attract a buyer.
The only way for this to happen is for the price to fall.
If interest rates fall, buyers of bonds would be willing to accept lower yields and bond prices would increase.
What is a flat yield?
The yield calculation includes only the calculation of yield divided by price.
What is the yield to maturity?
The yield calculation includes capital gain (or loss) if the bond is held to maturity.
Define credit risk.
Credit risk is the risk that the amount owing (the credit) may not be repaid.
Give two advantages of investing in bonds.
1) Predictable income in the form of regular fixed coupons.
2) Fixed date and amount to be repaid at redemption.
Give two disadvantages of investing in bonds.
1) Actual default - the failure of the issuer to be able to pay the coupons and/or the redemption amount.
2) An increased risk of default resulting in a fall in the bond’s value.
