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comm 308: introduction to corporate finance > chapter 6 book: Bond valuation > Flashcards

chapter 6 book: Bond valuation Flashcards

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1
Q

short term bonds, with a maturity of less than one year

A

called bills or paper

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2
Q

bonds, with a maturity of more than ten years

A

bonds

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3
Q

bonds, with a maturity between one and ten years

A

notes

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4
Q

the main bond issuers in Canada

A

federal, provincial, and municipal governments

government agencies

corporations

non-resident issuers

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5
Q

the main bond purchasers in Canada

A

institutional investors

in particular, insurance companies, pension funds, and bond mutual funds

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6
Q

The key feature of a bond

A

the issuer agrees to pay the bondholder (investor) a regular series of cash payments and to repay the full principal amount by the maturity date

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7
Q

bullet payment or balloon payment

A

a principal payment made in one lump sum at maturity

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8
Q

why are bonds often referred to as fixed income securities?

A

because the interest payments and the principal repayment are specified, or fixed, at the time the bond is issued

the bond purchaser knows the amount and timing of the future cash payments to be received, barring default by the issuer

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9
Q

what does the price of a bond depend on

A

will depend on the level of interest rates at that time

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10
Q

bond indenture

A

a legal document that specifies the payment requirements and all other salient matters relating to a particular bond issue, held and administered by a trust company

includes all relevant details for a particular bond issue

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11
Q

collateral

A

assets that can serve as security for the bond in case of default

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12
Q

fiduciary

A

The trust company makes sure that the covenant provisions within the indenture are observed by the issuer

a third party who acts to ensure that the best interests of bondholders are upheld

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13
Q

covenant provisions

A

clauses within the indenture that lay out the legal rights of the bondholder and the obligations of the issuer

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14
Q

The par value, also known as face value or maturity value

A

represents the amount that is paid at maturity for traditional bonds

The par value of most bonds is $1,000

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15
Q

The term to maturity of a bond

A

the time remaining until the maturity date

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16
Q

interest payments, or coupons for a bond

A

determined by multiplying the coupon rate (which is stated on an annual basis) by the par value of the bond

amounts paid on a bond at regular intervals

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17
Q

mortgage bonds

A

debt instruments that are secured by real assets

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18
Q

debentures

A

either unsecured or secured by other assets not already as collateral for other deb instruments

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19
Q

mortgage bonds

A

debt instruments that are secured by real assets

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20
Q

government bonds are mortgage bonds or debentures?

A

debentures

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21
Q

Collateral trust bonds

A

secured by a pledge of other financial assets, such as common shares, bonds, or treasury bills

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22
Q

Equipment trust certificates

A

secured by equipment, such as the rolling stock of a railway

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23
Q

Protective covenants

A

clauses in the trust indenture that restrict the actions of the issuer

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24
Q

negative covenants

A

prohibit certain actions

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25
Q

positive covenants

A

specify actions that the firm agrees to undertake

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26
Q

Callable bonds

A

give the issuer the option to “call,” or repurchase, outstanding bonds at predetermined call prices

for this to happen, market interest rates must have declined

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27
Q

why do callable bonds have prices over par value when bought back?

(im not sure for this one)

A

because they represent more risk for the holder

it is like an incentive to attract holders

28
Q

retractable (or putable) bonds

A

allow the bondholder to sell the bonds back to the issuer at predetermined prices at specified times earlier than the maturity date

the maturity of the bond is retracted, or shortened

for this to happen, market interest rates must have increased

29
Q

callable bonds are allowed to be call back when market interest rates increase or decrease?

A

decrease

30
Q

retractable bonds are allowed to be sold back to the issuer when market interest rates increase or decrease?

A

increase

31
Q

extendible bonds

A

allow the bondholder to extend the maturity date of the bond

32
Q

Sinking fund provisions

A

require the issuer to set money aside each year so that funds are available at maturity to pay off the debt

33
Q

provisions are made in which two ways?

A
  1. the firm repurchases a certain amount of debt each year so that the amount of debt goes down
  2. the firm pays money into the sinking fund to buy other bonds, usually government bonds, so that money is available at maturity to pay off the debt
34
Q

Sinking fund provisions are advantageous to whom?

A

generally advantageous to issuers and not the holders

issuers avoid paying back full amount at maturity

35
Q

Purchase fund provisions

A

similar to sinking fund provisions

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

36
Q

Purchase fund provisions are advantageous to whom? why’

A

to the debt holder

they provide some liquidity and downward price support for the market price of the debt instruments

37
Q

Convertible bonds

A

can be converted into common shares at predetermined conversion prices

Convertible bonds may be offered to make debt issues more attractive to investors

38
Q

the price of a bond

A

the present value of the future payments on the bond

basically, the present value of the interest payments and the par value repaid at maturity

39
Q

discount bonds

A

bonds trading below par value

40
Q

premium bonds

A

bonds trading above par

41
Q

when market interest rates are lower than the bond coupon rate, the bond trades at premium or discount?

A

premium

42
Q

when market interest rates are higher than the bond coupon rate, the bond trades at premium or discount?

A

discount

43
Q

if interest rates decrease, what happens to bond prices?

A

bond prices increase

44
Q

if interest rates increase, what happens to bond prices?

A

they decrease

45
Q

how do the effects of a given change in market interest rates (yields) on the price of bonds (both increase and decrease) compare? how does a yield curve show this?

A

for a given change in interest rates, bond prices will increase more when rates decrease than they will decrease when rates increase

the curve is steeper for lower interest rates, which means that a given change in interest rates will have a much greater impact on bond prices when rates are lower than it will if they are higher

46
Q

the longer the time to maturity, the more or less sensitive the bond price is to changes in market rates? what does this mean in regards to risk?

A

the more sensitive the bond price is to changes in market rates

risks are increased for the bond holder

47
Q

when the coupon rate is the same as the market interest rate, what is the price of the bond?

A

the same as par

48
Q

which type of bond pay a higher amount at maturity, those with high coupon rates or low coupon rates?

A

low coupon rates

49
Q

interest rate risk

A

The sensitivity of bond prices to changes in interest rates

50
Q

which bonds have higher interest rate risks?

A

longer-term bonds with lower coupon rates with lower market yields

51
Q

duration of bonds

A

An important measure of interest rate risk

measures the approximate percentage change in the price of a bond for a given change in the appropriate market interest rate

52
Q

two crucial points of duration

A
  1. The prices of bonds with higher durations are more sensitive to interest rate changes than are those with lower durations
  2. All else being equal, durations will be higher when (1) market yields are lower, (2) bonds have longer maturities, and (3) bonds have lower coupons
53
Q

cash price of a bond

A

price of a bond plus the accrued interest

54
Q

The discount rate used to evaluate bonds

basically, the market interest rate

A

the yield to maturity (YTM)

55
Q

The current yield (CY)

A

the ratio of the annual coupon interest divided by the current market price

CY = Annual Interest / B

not a true measure of the return to a bondholder because it disregards the bond’s purchase price relative to all the future cash flows

only uses just the next year’s interest payment

56
Q

what are the similarities or differences between YTM, bond rate, and current yield if the bond is trading at par?

A

they will all be the same

57
Q

what are the similarities or differences between YTM, bond rate, and current yield if the bond is trading at discount?

A

Coupon rate < CY < YTM

because lower bond prices mean that the YTM (market interest rates) is higher than Coupon rate

58
Q

what are the similarities or differences between YTM, bond rate, and current yield if the bond is trading at premium?

A

Coupon rate > CY > YTM

because higher bond prices mean that the YTM (market interest rates) is lower than Coupon rate

59
Q

Treasury bills (T-bills)

A

short-term government debt obligations that mature in one year or less

do not make regular interest payments but are sold at a discount from their par (or face) value

The interest earned is the difference between the purchase price and the face value

60
Q

treasury bill formula

A

P = F / (1 + (KBEY · n/365))

61
Q

A zero coupon bond

A

structured similarly to a long-term T-bill

does not make regular interest payments but is issued at a discount and repays the par value at the maturity date

The return earned represents the difference between the purchase price and the redemption price

we value these bonds by assuming semi-annual discounting periods

62
Q

formula for zero coupon bond

A

same as PV shit

63
Q

which is more sensitive to market interest rate changes between regular bonds and zero coupon bonds? why?

A

zero coupon bonds

because they make no coupon payments at all

64
Q

Floating rate bonds (floaters)

A

have adjustable coupons that are usually tied to some variable short-term rate

the coupon rates increase as interest rates increase and vice versa

provide protection against rising interest rates and tend to trade near their par value

65
Q

Real Return Bonds

A

provide investors with protection against inflation

provide real yield in which a nominal yield is adjusted for inflation

we peg the face value to the rate of inflation (as measured by the CPI) and having the coupon rate apply to the inflation-adjusted face value

66
Q

Canada Savings Bonds (CSBs)

A

they cannot be traded and have no secondary market

their prices do not change over time

67
Q

the only two forms that Canada Savings Bonds (CSBs) are available

A

(1) regular interest bonds, which pay out the annual interest amounts
(2) compound interest bonds, which reinvest the interest,

comm 308: introduction to corporate finance (13 decks)

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