Chapter 6: An Introduction to Debt Instruments

Question 1

Debt Instrument

Answer 1

Written agreement/formal promise that allows the issuer to generate capital by vowing to pay back the lender according to the stipulations of the agreement

Question 2

What are some examples of long term debt instruments?

Answer 2

Bonds, mortgages, and long-term loans

Question 3

What are some examples of medium/short term debt instruments?

Answer 3

Working loans, treasury bills, and short-term loans

Question 4

Bond

Answer 4

Fixed-yield financial tool that characterizes credit extended by an investor to a debtor, generally governmental or commercial entities

Question 5

Term Bonds

Answer 5

Requires repayment of the principal sum at a single maturity date

Question 6

Sinking Fund

Answer 6

Investment pool specifically designated to earmark monetary reserves that will be used to settle the debt as it comes due and payable

Question 7

Serial Bonds

Answer 7

Requires payments in installments over a period of time

Question 8

Zero-Coupon Bond

Answer 8

Holder does not receive interest but trades at a deep discount and investor receives profit at maturity

Question 9

What is an example of a zero-coupon bond?

Answer 9

Treasury bills

Question 10

Zero-coupon bonds eliminate what?

Answer 10

Reinvestment risk

Question 11

Bond Maturity

Answer 11

Point in time where the holder of the bond will receive a return that includes interest

Question 12

Is the interest earned from zero-coupon bonds taxed?

Answer 12

Yes

Question 13

How does interest accumulate for zero-coupon bonds?

Answer 13

Semi-annually at a predetermined rate

Question 14

Carrying Value

Answer 14

Face value adjusted for any premium or discount

Question 15

Carrying Value Equation

Answer 15

Bonds payable + premium on bonds - discount on bonds

Question 16

Reinvestment Risk

Answer 16

Bonds pay periodic interest but there is risk that payments will have to be reinvested at lower cost

Question 17

Why do bond prices fluctuate?

Answer 17

Because they depend on income provided by coupon payments related to interests

Question 18

Interest-Rate Risk

Answer 18

Any potential change in overall interest rate will reduce the value of a bond

Question 19

Credit Risk

Answer 19

Loss from borrower’s failure to repay a loan or failure to meet the contractual obligations

Question 20

Examples of credit rating companies

Answer 20

Standard and Poor’s, Fitch Ratings, Moody’s Investor Services

Question 21

Credit Rating

Answer 21

Tool that determines fiscal responsibility of a borrower, either in relation to a specific debt or more generally

Question 22

Investment Grade

Answer 22

Allow money to be loaned and investments to be made

Question 23

Speculative Grade

Answer 23

Carries substantial credit risk and indicates a higher risk that issuers may not meet their obligations

Question 24

Coupon Rate

Answer 24

Interest rate an issuer agrees to pay every year on a fixed-income security

Question 25

Benefit of government securities

Answer 25

Low default risk; interest exempt from local or state taxes; issued at par value

Question 26

Bond Yield

Answer 26

Return an investor receives annually

Question 27

Bond yields are inversely related to…

Answer 27

Bond Prices

Question 28

Normal Yield

Answer 28

Up-sloped curve that indicates that yields rise on a long-term bond

Question 29

Current Yield

Answer 29

Ratio of interest rate payable on a bond to the actual market price of the bond represented as a percentage

Question 30

Yield to Maturity

Answer 30

Promised compound rate of return received from a bond purchased at the current market price and then held until its maturity

Question 31

Retiring Debt Before Maturity

Answer 31

Happens when a long-term debt of a company is retired before maturity

Question 32

Call Provision

Answer 32

Clause embedded in the contractual agreement governing a bond or any similar fixed-income instrument that grants the issues the prerogative to repurchase and subsequently retire the debt security

Question 33

Optional Call Provision

Answer 33

Bond can be called whenever the issuer feels like calling it

Question 34

Sinking Fund Call Provision

Answer 34

Issuer redeems a specific number of bonds on a set schedule

Question 35

Extraordinary Call Provision

Answer 35

Issuer redeems the bonds when certain conditions have been met

Question 36

Mandatory Call Provision

Answer 36

Issuer specifies the circumstances when they might call the bond

Question 37

Put Provision

Answer 37

Gives the bond owner the right to cash it in at its face value at a predetermined time before its maturity date

Question 38

Convertible Debenture

Answer 38

Form of financial debt that is issued by a corporate identity; can be converted into shares after a predetermined duration

Question 39

Convertible bond offers investors what?

Answer 39

Security of a debt instrument along with the high growth potential of an equity investment

Question 40

Fully Convertible Debenture

Answer 40

Whole value of the debentures can be converted into equity shares

Question 41

Partially Convertible Debenture

Answer 41

Only part of the debentures are eligible for conversion into equity shares

Question 42

Conversion Parity Price

Answer 42

Price an investor has paid for the conversion of a company’s bonds into shares