Chapter 6 Flashcards
Why would an issuer consider issuing a debt instrument?
- to finance growth and operations
2. to take advantage of financial leverage
What does the par value of a bond refer to?
par value = face value of a bond, the principal amount owing at maturity
Describe the difference between the coupon rate and yield
coupon rate = interest paid by the issuer relative to the par value. semi-annual payments
yield = annual return on a bond that is held to maturity
What is the primary difference between a bond a debenture?
bond = secured by physical assets
debenture = unsecured, backed by general creditworthiness of issuer
How is a strip bond created? (zero-coupon bond)
Created when a dealer acquires a block of high-quality bonds, and separates interest coupons from the rest of the bond
Dealer sells coupons separately
How does strip bonds differ from regular bonds?
Strip bonds receive no interest payments, instead receive compounded rate of return at maturity. strip bonds trade at a discount to par
Callable bond v convertible bond
callable bond = issuer receives the RIGHT, not obligation to pay off bond before maturity.
convertible bond = allows investors to lock in a specific price for common shares of the company. when stock price of company is below conversion price, it acts like a normal fixed-income.
Sinking fund v Purchase fund
sinking fund = sums of money set aside to provide repayment of debt issue by maturity
purchase fund = set up to retire a specific amount of the bond through purchases in the market
Describe 5 protective covenants
Security; clause includes details of the assets that support debt
Negative pledge; borrower will not pledge if results in less security
Limitation on sale and leaseback transaction; protects holder against firm selling and leasing back assets
Sale of assets or merger; protects holder in event of sale or merge
Dividend test; establishes rules for payment of dividends by firms
Debt test; limits amount of additional debt a firm may issue
Additional bond provisions;
Sinking or purchase fund and call provisions
What is a T-bill?
Short term government obligations, do not pay interest, sold at discount and mature at 100
Sold at auction every 2 weeks, maturity is 3 mth, 6 mth, 1 year
How do federal, provincial, municipal bonds compare to each other
Federal
Gov of C issues bonds for infrastructure, finance deficits, fund programs. G of C issues marketable bonds in their own name. Transferable, noncallable, highest quality rating. T-bills for short term government obligations
Provincial
Debentures. Value depends on province’s ability to pay interest and repay principal, not pledged as security. Second in quality to federal bonds. Guaranteed bonds; provinces guarantee the bond issues of provincially appointed authorities
Municipal
Instalment debentures/serial bond. Non-callable, credit rating depends on taxation resources
Describe first mortgage bonds
Senior securities of a company. Constitute first charge on company’s assets, before unsecured liabilities are paid. Best security a company can issue
Describe collateral trust bonds
Secured by a pledge of securities or collateral. Collateral bonds are issued by companies that own few fixed assets
What is an equipment trust certificate?
Pledge equipment as security instead of real property. locomotives use rolling stock as security
Floating rate bonds v regular bonds
Floating rate securities/variable rate securities; corporate issue that automatically adjusts to changing interest rates
