chapter 6

Question 1

what is a fixed income security

Answer 1

provides a known income stream to the holder and has a known maturity date

Question 2

define bonds

Answer 2

debt instruments that are secured by real assets - often called mortgage bonds

Question 3

what details are in the bond issue

Answer 3

payment, maturity, security, and bond covenants

Question 4

define a bond trust indenture

Answer 4

a legal contract between the bondholders and the bond issuers

Question 5

how are bond prices quoted

Answer 5

based on an index with a base value of 100

Question 6

when are bonds said to be traded at a premium

Answer 6

traded above 100

Question 7

when are bonds said to be traded at a discount

Answer 7

traded below 100

Question 8

when are bonds to be traded at par/face value

Answer 8

bonds trade at 100

Question 9

define the face value

Answer 9

represents the amount the issuer contracts to pay at maturity

Question 10

define the term to maturity

Answer 10

the remaining life of the bond

Question 11

what are the maturities of short/medium/long term bonds

Answer 11

short: 1-5 years
medium: 5-10 years
long: over 10 years

Question 12

liquid bonds vs negotiable bonds vs marketable bonds

Answer 12

liquid bonds = have significant trading volumes
negotiable bonds = in deliverable form
marketable bonds = those for which there is a ready market

Question 13

what are the 3 main reasons for borrowing money

Answer 13

1. match the term of assets with the term of liabilities,
2. to benefit from the use of financial leverage
3. to fund deficits

Question 14

what are the interest payments on bonds based on?

Answer 14

based on the stated coupon rate and generally paid semi-annually

Question 15

define a floating-rate bond

Answer 15

have “adjustable” coupons that are typically tied to treasury bill rates or some other short-term interest rate

Question 16

why are floating-rate bond attractive

Answer 16

for the protection offered in times of volatile interest rates and behave like money market securities in an investment portfolio

Question 17

define callable/redeemable bonds

Answer 17

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

Question 18

define call protection

Answer 18

period of time prior to the first call date during which callable bonds cannot be called

Question 19

define the redemption price

Answer 19

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

Question 20

what are sinking fund provisions

Answer 20

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.

Question 21

define sinking funds

Answer 21

the funds set aside by the company for this purpose

Question 22

what are purchase fund provisions

Answer 22

require the repurchase of a certain amount of debt only if the debt can be repurchases at or below the given price

Question 23

define retractable bonds

Answer 23

allow the bondholder to sell bonds back to the issuer at predetermined prices at specified times

Question 24

define extendible bonds

Answer 24

allow the bondholder to extend the maturity date of the bond

Question 25

what are convertible bonds

Answer 25

may be converted into common shares at predetermined conversion prices.

Question 26

what are some characteristics convertible bonds

Answer 26

most have a protection against dilution

most are callable and have a sinking fund

certain convertibles include a forced conversion clause

Question 27

what are premiums

Answer 27

as market price approaches conversion price and it is said to sell off the stock once market price exceeds the conversion price

Question 28

what’s the payback period for a convertible?

Answer 28

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

Question 29

what’s a general rule of thumb for payback period

Answer 29

payback periods beyond 2 years are unattractive