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FN1 corporate finance > Chapter 6 part 1 from notes > Flashcards

Chapter 6 part 1 from notes Flashcards

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1
Q

Definition of bills or papers

A

short term bonds with a maturity of less than one year

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2
Q

Collateral trust bonds

A

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

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3
Q

mortgage bonds

A

debt instruments that are secured by real assets

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4
Q

collateral trust bonds

A

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

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5
Q

Notes

A

bonds with maturities b/w 1 and 7 years

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6
Q

bonds

A

long-term debt instruments that promise fixed payments and have maturities of longer than 7 years

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7
Q

who are the main bond issuers

A
  • federal, provincial and municipal gov
  • government agencies (eg Canada mortgage and housing corp, hydro Quebec)
  • coroporation and on-resident issuers (maple bond market)
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8
Q

who are the main purchasers of bonds

A

institutional investors (insurance companies, pension funds and bond mutal funds)

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9
Q

a bond is what

A

any debt instrument that promises a fixed income stream to the holder until the maturity date

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10
Q

where do you find the promises of the bond

A

in a contract and are a fixed contractual commitment

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11
Q

how often do bonds pay interest or the coupon

A

semin-annually or annually and full principal payment at maturity

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12
Q

what is a bullet payment or balloon payment

A
  • when the principal payment is made in one lump sum at maturity
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13
Q

what are bonds sometimes refered to as and why

A

fixed income securities

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

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14
Q

if the buyer decides to sell the bond before maturity what happens to the price received

A

the price recived will depend on the level of interest rates at that time

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15
Q

How is a bond’s structure different from a loan or mortgage

A
  • beause it had blended payments (principal and interest)
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16
Q

a bond can be viewed as 2 separate components what are they

A
  1. an annuity (consisting of identical and regular interest payments)
  2. a lump sum payment a maturity
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17
Q

what is a bond indenture

A

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

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18
Q

what is collateral

A

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

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19
Q

what are 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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20
Q

what is par value

A

also called face value or marturity value

- amount paid at marturity

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21
Q

what is term to maturity

A

time remaining to maturity date

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22
Q

what are interest payments or coupons

A

amounts paid on a bond at regular intervals

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23
Q

what is the par value on most bonds

A

$1,000

although bond prices are typically quoted on par value of 100

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24
Q

if the price of a bond is quoted at $99,583, a $1,000 par value bond would be selling at what

A

$995.83

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25
Q

How are interest payments or coupons determined

A

by multiplying coupon rate (stated on annual basis) by par value of the bond

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26
Q

a bond with a coupon rate of 6% and a par value of $1,000 would pay a coupon of

A

$60 annual or $30 every 6 months

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27
Q

what are mortgage bonds

A

debt instruments that are secured by real assets

- not all bonds are secured by real property

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28
Q

what are debentures

A

debt instruments similar to bonds but are generally unsecured or are secured by a general floating charge over the company’s unencumbered assets (those assets that have not been pledged as security for other debt obligations)

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29
Q

what are some examples of debentures

A

gov bonds, because no specific security is pledged as collateral
- called bonds as a matter of convention

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30
Q

what are collateral trusts and bonds secured by

A

a pledge of other financial assets

such as common shares, bonds or treasury bills

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31
Q

what are equipment trust certificates

A

a type of debt instrument secured by equipment

- such as railway rolling stock

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32
Q

what are protective covenants

A

clauses in the trust indentrue that restricts the actions of the user

  1. negative covenants
  2. positive covenatns
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33
Q

what are negative covenants

A

restrict certain actions

  • restrict a company form making a dividend payment over a ceratin amount
  • or prevent them from pledging assets to another lender
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34
Q

what are positive covenants

A

specify actions that the firm agrees to undertake

- company may promise to provide quarterly f.s. or maintain certain working capital levels

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35
Q

what are some bond features or options

A
  1. callable bonds, call prices, retractable bonds, extendible bonds, sinking fund provisions, purchase fund provisions, convertible bonds
36
Q

what is a callable bonds

A

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

37
Q

what are call prices

A

generally at a premium over par, at which issuers can repurchase bonds

38
Q

what are retractable bonds

A

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

39
Q

what are extendible bonds

A

bonds that allow the bond holder to extend the maturity date of the bonds

40
Q

what are sinking fund provisions

A

the requirement that an issuer set aside funds each year to be used to pay off the debt at maturity

41
Q

what are purchase fund provisons

A

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

42
Q

what are convertible bonds

A

bonds that can be converted into common shares at predetermined conversion prices

43
Q

how do you determine the price of a bond and what do you need to know

A
  1. must know par value, term to maturity and coupon rate

2. use an appropriate discount rate to discount the bond (often called the market rate of interest)

44
Q

what are the factors that affect the discount rate

A
  1. function of market conditions (ie other market interest rates)
  2. factors specific to issue and issuer
45
Q

what is the price of the bond

A

the PV of the future, which is the PV of the interest payments and the par value repaid at maturity

46
Q

what is a discount

A

difference b/w a bond’s par value and the price it trades at when it trades below the par value

47
Q

if the coupon rate is less than the market interest (discount) rate what is the bond trading at

A

a discount

48
Q

because coupon rates are fixed, the only way to get a higher return is to

A

pay less than par value for it

49
Q

what is par value

A

when market rate = coupon rate

50
Q

what is premium

A

when market interest rates are below coupon rate

51
Q

what are the factors affecting bond prices

A

1, interest rates
relationship b/w market rates and bond prices
3. relationship b/w coupon rate an dbond’s ytm

52
Q

if interest rates decrease

A

market prices of bonds increase and vice versa

53
Q

the relationship between market rates and bond prices is

A

not linear; the curve is convex

54
Q

interest rates are inversely related to bond prices

A

bond prices increase when interest rates decrease and vcie versa

55
Q

the relationship b/w the coupon rate and the bond’s YTM

A

determines if the bond will sell at a premium or a discount or par

56
Q

if the coupon rate is greater than YTM

A

price is greater than face value = discount

57
Q

if coupon rate = YTM

A

price = face value , par

58
Q

if coupon rate Iess than YTM

A

prices is less than Face value = Preimum

59
Q

what are the factors that affect bond prices

A
  1. YTM
  2. time to maturity
  3. size of coupon
  4. interest rate risk and duration
60
Q

what affects the volatility of a bond

A

YTM, time to maturity and size of coupon

61
Q

how does time to maturity affect a bond

A

long-maturity bonds have greater price volatility than short-maturity bonds
- the longer the bond, the longer the period for which the cash flows are fixed

62
Q

how does the size of the coupon affect the bond

A

low coupon bonds have greater price volatility than high coupon bonds

63
Q

what do high coupon bonds act like

A

a stabilizing device
- since a greater proportion of the bond’s total cash flow occurs closer to today and are therefore the PV is less affected by a change in YTM

64
Q

how does interest rate risk and duration affect the bond

A

sensitivity of a bond’s price to change in interest rates is a measure of the bond’s interest rate risk
- interest rate risk is affected by YTM, Term to Maturity, and size of coupon

65
Q

the impact of interest rate risk is measured using

A

duration

66
Q

duration measures

A

of interest rate risk as a change in price for a given change in interest rates

67
Q

a bond’s duration will be higher if its:

A
  • YTM is lower
  • Term to maturity is longer
  • coupon is lower
68
Q

what is the quoted price

A

the price quoted by the media

69
Q

what is the cash price

A

the price paid by an investor

- includes both the quoted price plus any interest that has accrued since the last coupon payment date

70
Q

what is YTM an investor would earn if

A

the discount rate used for bond valuation

  • YTM is the yield an investor would earn if
    • she purchased the bond at the current market price
  • she holds the bond to maturity
  • she reinvests all of the coupons paid by the bond at the YTM (also gets all scheduled payments)
71
Q

YTM is what

A

the bond’s internal rate of return (IRR)

- its also the discount rate that cause the PV of the bond’s future cash flow to equal its current price

72
Q

what is the YTM on a 6% semi-annual coupon bond with 20 years to maturity that is selling for $1,030

A

(2nd) (Clrtvm) 30 (PMT) -1030 (PV) 1,000 (FV) 40 (N) (CPT) (I/y) =2.87
next 2.87 x 2 to annualize
= 5.74
- always enter the price as a negative since it is a cash outflow
- then enter the coupon and principal payments as positive numbers since these are cash inflows

73
Q

what is the YTC yield to call

A

if the bond has a call feature
- the issuer can call (or force the investor to sell the bond back to them) before the maturity date stated in the bond indenture

74
Q

callable bonds are initially protected from what

A

from call for a period of a few years (5,7, or 10)

- after which the issuer can call the bond

75
Q

estimate the YTC on a 20 year 6% bond that is callable in 5 years at a call price of $1,050. if the bond pays semi-annual copuons and is selling for $1,030

A 
30 PMT
-1030 PV
1050 FV
N 10 
CPT I/1 = 3.081% semi - annual rate 
x 2 to annualize 
= 6.16% annual YTC
76
Q

when the call price is above the current market price (regarding callable bonds)

A

unlikely to be called back by the issuer

- therefore it is selling based on its YTM not YTC

77
Q

the bond would trade on its YTM if (regarding callable bonds0

A

it was likely the bond would be called

- occur if the bond were trading above its call price

78
Q

how does the bond usually trade off for callable bonds

A

whichever is lower, the

79
Q

what is the current yield

A

the ratio of the annual coupon interst dividend by the current market price

  • not a true measure of the return to a bond holder
  • because it disregards the bond’s purchase price relative to all future cash flows and
  • uses just the next year’s interst payment
80
Q

what is the current yield also called

A

the flat or cash yield

81
Q

what is the formula for Current yield

A

CY = annual interest / B

82
Q

determine the current yield for a bond with a 5.5% coupon and a current market price of $1,050

A

5.5/ 1050 = 5.24%
notice on last page the current yield is not equal the coupon rate of 6% or the YTM of 5.74%
- this will be true unless the bond is trading at its face value, in which case all 3 rates will be equal

83
Q

if a bond trades at a premium the CY

A

the CY will be less than the coupon rate

- but cy grater than the YTM

84
Q

if a bond trades at a discount the CY

A

the cy will b e greater than the coupon rate but less than the YTM

85
Q

par value the coupon rate

A

coupon rate = cy= ytm

86
Q

discount the coupon rate

A

is less than CY and CY than tan YTM

87
Q

premium the coupon rate

A

is is greater than CY and CY is greater than YTM

FN1 corporate finance (44 decks)

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