chapter 6 Flashcards
Fixed-income securities: features + types
what is a fixed income security
provides a known income stream to the holder and has a known maturity date
define bonds
debt instruments that are secured by real assets - often called mortgage bonds
what details are in the bond issue
payment, maturity, security, and bond covenants
define a bond trust indenture
a legal contract between the bondholders and the bond issuers
how are bond prices quoted
based on an index with a base value of 100
when are bonds said to be traded at a premium
traded above 100
when are bonds said to be traded at a discount
traded below 100
when are bonds to be traded at par/face value
bonds trade at 100
define the face value
represents the amount the issuer contracts to pay at maturity
define the term to maturity
the remaining life of the bond
what are the maturities of short/medium/long term bonds
short: 1-5 years
medium: 5-10 years
long: over 10 years
liquid bonds vs negotiable bonds vs marketable bonds
liquid bonds = have significant trading volumes
negotiable bonds = in deliverable form
marketable bonds = those for which there is a ready market
what are the 3 main reasons for borrowing money
- match the term of assets with the term of liabilities,
- to benefit from the use of financial leverage
- to fund deficits
what are the interest payments on bonds based on?
based on the stated coupon rate and generally paid semi-annually
define a floating-rate bond
have “adjustable” coupons that are typically tied to treasury bill rates or some other short-term interest rate
why are floating-rate bond attractive
for the protection offered in times of volatile interest rates and behave like money market securities in an investment portfolio
define callable/redeemable bonds
give hte issuer the option to “call” or repurchase outstanding bonds at predetermined call prices at specified times - this feature = detrimental to the bondholders who are willing to pay less for them than for similar non-callable bonds
define call protection
period of time prior to the first call date during which callable bonds cannot be called
define the redemption price
often based on a graduated scale, reflecting that the hardship to the investor of having an issue called is reduced as the time to maturity declines
what are sinking fund provisions
require the issuer to repurchase a certain amount of debt per year - they benefit the issuers bc it helps them to avoid having to come up with the entire face value of the issue at the maturity date.
define sinking funds
the funds set aside by the company for this purpose
what are purchase fund provisions
require the repurchase of a certain amount of debt only if the debt can be repurchases at or below the given price
define retractable bonds
allow the bondholder to sell bonds back to the issuer at predetermined prices at specified times
define extendible bonds
allow the bondholder to extend the maturity date of the bond
what are convertible bonds
may be converted into common shares at predetermined conversion prices.
what are some characteristics convertible bonds
most have a protection against dilution
most are callable and have a sinking fund
certain convertibles include a forced conversion clause
what are premiums
as market price approaches conversion price and it is said to sell off the stock once market price exceeds the conversion price
what’s the payback period for a convertible?
measure how long it would take to recover its premium through the difference between its dividend yield versus the lower yield provided by the underlying stock
what’s a general rule of thumb for payback period
payback periods beyond 2 years are unattractive
