CHAPTER 6 Flashcards
• Par or Face Value
o The principal amount of a bond that is repaid at the end of the term. Also par value.
• Coupon and Coupon Rate
o The stated interest payment made on a bond.
o The annual coupon divided by the face value of a bond.
• Interest Rate Risk
o How much interest rate risk a bond has depends on how sensitive its price is to interest rate changes. Depends on two variables: the time to maturity and the coupon rate.
o All other things being equal, the longer the time to maturity, the greater the interest rate risk.
o All other things being equal, the lower the coupon rate, the greater the interest rate risk.
• Yield-to-maturity
o The rate required in the marked on a bond,
• Current yield
o A bond’s coupon payment divided by its closing price
• Default risk premium
o The portion of a nominal interest rate of bond yield that represents compensation for the possibility of default.
• Interest rate risk (price risk) premium
o The compensation investors demand for bearing interest rate risk.
• Call provisions and Call premium
o Call Provision: Agreement giving the issuer the option to repurchase a bond at a specific price prior to maturity.
o Call Premium: The amount by which the call price exceeds the par value of the bond.
• Credit ratings
o Represent forward-looking statements about the creditworthiness and credit risk of a particular organization in meeting its financial meetings.
• Investment grade debt
o Low risk of default. Securities with a rating of BBB or above from Standard and Poor’s or Baa3 or above from Moody’s are considered investment grade.
• Indenture
o The written agreement between the corporation and the lender detailing the terms of the debt issue.
• Debenture
o Unsecured debt, usually with a maturity of 10 years or more.
• Bid and Asked price
o Bid Price: The price a dealer is willing to sell for a security.
o Asked Price: The price a dealer is willing to pay for security.
o Bid-Ask Spread: The difference between the bid price and the asked price. Broker’s profit.
• Zero-coupon bonds
o A bond that makes no coupon payments, and thus is initially priced at a deep discount.
• Government bonds
o US Treasury: Issues no default risk because the Treasury always can come up with the money to make the payments. Also are exempt from state income taxes.
• Municipal bonds:
o Have a varying degrees of default risk and are rates much like corporate issues. They are always callable. Also several are exempt from federal income taxes and state income taxes. Because of these, the bond yields are much lower.
• Real and nominal interest rates
o Real interest rates: Rates adjusted for inflation
o Nominal interest rates: Interest rates or rates of return that have not been adjusted for inflation.
• Term structure of interest rates (yield curve)
o The relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money.
• What roles do the coupon interest rate and the yield-to-maturity interest rate play in a bond’s valuation?
o Coupon Interest Rate matches the Yield to Maturity interest rates, the bonds valuation is its face value. When the YTM is more than Coupon Interest rate, the bond’s valuation is less then the face value (discount bond). When the YTM is less than the CR, the bond’s valuation is more than the face value (premium bond).
