chapter 5 bonds Flashcards
what is a bond?
a debt instrument whereby an investor lends money to an entity (such as a company or a government) that borrows the funds for a defined period of time at a fixed interest rate
what is the main reason for issuing bonds?
for the issuer to raise finance, perhaps to fund something in particular
what are the three major ways for a company to raise finance?
- bonds
- bank loans
- equity issues
what are the two major groups of bond issuers?
companies and governments
what are bonds issued by companies known as?
corporate bonds
what is the nominal value?
the amount that is owed by the bond issuer, and that will be repaid on the repayment date
what is another term for the nominal value?
face value or par value
what is the repayment date?
when the money will be returned
what does it mean for bonds to be ‘tradeable’?
bonds can be sold before they reach their repayment date
what would happen to the bond price if interest rates in the economy increased?
- the required yield would increase
- so the bond price would fall so that the yield it provides the buyer is competitive
what is the flat yield?
when the yield calculation includes only the calculation of coupon divided by price
what is the relationship between yield and bond prices?
inverse relationship - if required yields increase, bond prices decrease and vice versa
what is the yield of a bond being priced at face value?
the same as the coupon
why are bond prices susceptible to movements in general interest rates?
for their yield to be attractive to an investor it needs to remain competitive with the return available on alternative investments
what are the advantages of investing in bonds?
- predictable income in the form of regular, fixed coupons
- fixed date and amount to be repaid at redemption
what are the disadvantages of investing in bonds?
- actual default, the failure of the issuer to be able to pay the coupons and/or the redemption amount
- an increased risk of default resulting in a fall in the bond’s value
what does being in default mean?
the situation where a borrower has failed to meet the requirements of their borrowing, for example by failing to pay the interest due
what is the credit risk?
the risk that the amount owing (the credit) may not be repaid by the issuer
what is leverage?
the proportion of debt finance compared to equity finance in the company
who are the three dominant credit rating agencies globally?
- Moody’s
- Standard & Poor’s
- Fitch Ratings
which two credit rating agencies use an identical scale?
Standard & Poor’s and Fitch
what is the relationship between credit risk and a company’s rating on the scale?
as the credit risk of the issuer increases, the assessment from the agencies moves down the scale with the lowest for Standard & Poor’s and Fitch Ratings being D (this is generally for issuers already in default and failing to pay the bond coupons)
what is the lowest rating from Moody’s?
C
which ratings are categorised as investment grade?
- AAA (Aaa)
- AA (Aa)
- A
- BBB (Baa)
which ratings are categorised as non-investment grade?
- BB (Ba)
- B
- CCC (Caa)
- CC (Ca)
- C
- D
where is the dividing line between investment grade and non-investment grade bonds?
right below Standard & Poor’s BBB and Moody’s Baa levels
what is the benefit of having a high leverage?
the larger the leverage, the more the gain to shareholders is magnified
what is the yield to maturity?
the sum of the flat yield and the gain or loss until maturity
