Chapter 6 - Fixed-Income Securities: Features and Types (Done)

Question 1

What does the par value of a bond refer to?

Answer 1

The par value, or face value, of a bond is the amount that will be returned to the bondholder at maturity. It is the nominal value of the bond, usually $1,000, and it is the basis for calculating interest payments.

Question 2

Why would an issuer consider issuing a debt instrument?

Answer 2

Issuers, such as corporations or governments, issue debt instruments (like bonds) to raise capital. This can be for funding projects, expansion, operational needs, or refinancing existing debt. Debt instruments are a way to obtain funds without giving up ownership or control, unlike issuing equity.

Question 3

Can you describe the difference between the coupon rate and the yield?

Answer 3

• Coupon Rate: The fixed interest rate paid by the bond issuer on the bond’s par value. It is expressed as a percentage of the par value and paid periodically.
• Yield: The return on the bond, considering the current market price. It can vary over time and is influenced by the bond’s price, coupon payments, and time to maturity.

Question 4

What is the primary difference between a bond and a debenture?

Answer 4

• Bond: Typically secured by collateral or specific assets, providing bondholders with a claim on those assets if the issuer defaults.
• Debenture: Unsecured and backed only by the issuer’s creditworthiness and reputation. It carries a higher risk compared to secured bonds.

Question 5

How is a strip bond created?

Answer 5

A strip bond, also known as a zero-coupon bond, is created by separating the interest payments (coupons) from the principal repayment. Each component is sold individually as a separate security. The investor buys the bond at a discount and receives the full par value at maturity, without periodic interest payments.

Question 6

How does a strip bond differ from a regular bond?

Answer 6

• Strip Bond: Pays no periodic interest and is sold at a discount, with the return realized at maturity when the par value is paid.
• Regular Bond: Pays periodic interest (coupons) over its life, and the principal is repaid at maturity.

Question 7

What is the difference between a callable bond and a convertible bond?

Answer 7

• Callable Bond: Can be redeemed by the issuer before maturity at a predetermined call price, allowing the issuer to refinance if interest rates decline.
• Convertible Bond: Can be converted into a predetermined number of the issuer’s equity shares, offering potential for capital appreciation if the issuer’s stock performs well.

Question 8

Can you compare sinking funds with purchase funds?

Answer 8

• Sinking Fund: A reserve set aside by the issuer to repay the bond at maturity or to buy back a portion of the bonds each year. It reduces default risk by ensuring funds are available for repayment.
• Purchase Fund: Similar to a sinking fund but used to buy back bonds in the open market when the price is favorable, potentially reducing the overall cost of debt.

Question 9

Can you describe five protective covenants?

Answer 9

• Debt Covenant: Limits the issuer’s ability to incur additional debt.
• Dividend Covenant: Restricts dividend payments to preserve cash for bondholders.
• Asset Covenant: Requires maintaining certain asset levels or restricting asset sales.
• Financial Covenant: Mandates maintaining specific financial ratios (e.g., debt-to-equity ratio).
• Operational Covenant: Sets limits on business operations or investments.

Question 10

What is a treasury bill?

Answer 10

A Treasury bill (T-bill) is a short-term government debt instrument with maturities ranging from a few days to one year. It is issued at a discount to its par value and pays no interest, with the return realized at maturity.

Question 11

How do federal, provincial, and municipal bonds compare to each other?

Answer 11

• Federal Bonds: Issued by the national government and considered the safest, with low risk and lower yields.
• Provincial Bonds: Issued by provincial governments, slightly higher risk than federal bonds, and offer higher yields.
• Municipal Bonds: Issued by local governments or municipalities, with varying risk levels depending on the issuer’s financial health and the specific project’s backing.

Question 12

Can you describe a first mortgage bond?

Answer 12

A first mortgage bond is secured by a lien on specific property or assets. It gives bondholders the first claim on the collateral in case of default, making it safer than unsecured debt.

Question 13

Can you describe a collateral trust bond?

Answer 13

A collateral trust bond is secured by financial assets like stocks or bonds held in trust by a third party. If the issuer defaults, the trustee can sell the collateral to repay bondholders.

Question 14

What is an equipment trust certificate?

Answer 14

An equipment trust certificate is a type of secured bond used to finance the purchase of equipment, like railway cars or aircraft. The equipment serves as collateral, and ownership remains with the trustee until the debt is repaid.

Question 15

How do floating-rate bonds differ from regular bonds?

Answer 15

• Floating-Rate Bonds: Have variable interest rates that adjust periodically based on a benchmark rate, reducing interest rate risk for investors.
• Regular (Fixed-Rate) Bonds: Have fixed interest rates that do not change over the bond’s life, exposing investors to interest rate risk if market rates rise.

Question 16

Can you describe a corporate note?

Answer 16

A corporate note is a short- to medium-term debt instrument issued by a corporation, typically with maturities ranging from one to ten years. It pays periodic interest and is used for various financing needs.

Question 17

Can you explain the difference between a domestic bond, a foreign bond, and a Eurobond?

Answer 17

• Domestic Bond: Issued in the issuer’s home country and denominated in the local currency.
• Foreign Bond: Issued in a foreign country and denominated in that country’s currency (e.g., a Japanese company issuing bonds in the U.S. denominated in dollars).
• Eurobond: Issued in a currency different from the issuer’s home currency and sold in international markets (e.g., a U.S. company issuing bonds in euros).

Question 18

What is a bankers’ acceptance?

Answer 18

A banker’s acceptance is a short-term debt instrument issued by a company and guaranteed by a bank. It is used in international trade to finance goods and services, with the bank promising to pay the face value at maturity.

Question 19

What is a non-redeemable GIC?

Answer 19

A non-redeemable Guaranteed Investment Certificate (GIC) is a fixed-term deposit offered by banks or financial institutions. It pays a fixed interest rate but cannot be cashed out before maturity without penalties.

Question 20

What role does DBRS, Moody’s Canada, and Standard & Poor’s play in the bond market?

Answer 20

These credit rating agencies assess the creditworthiness of bond issuers and assign ratings that indicate the risk level of the bonds. Higher ratings suggest lower risk, influencing interest rates and investors’ decisions.