Chapter 6 part 1 from notes Flashcards
Definition of bills or papers
short term bonds with a maturity of less than one year
Collateral trust bonds
bonds secured by a pledge of other financial assets, such as common shares, bonds or treasury bills
mortgage bonds
debt instruments that are secured by real assets
collateral trust bonds
bonds secured by a pledge of other financial assets, such as common shares, bonds or treasury bills
Notes
bonds with maturities b/w 1 and 7 years
bonds
long-term debt instruments that promise fixed payments and have maturities of longer than 7 years
who are the main bond issuers
- federal, provincial and municipal gov
- government agencies (eg Canada mortgage and housing corp, hydro Quebec)
- coroporation and on-resident issuers (maple bond market)
who are the main purchasers of bonds
institutional investors (insurance companies, pension funds and bond mutal funds)
a bond is what
any debt instrument that promises a fixed income stream to the holder until the maturity date
where do you find the promises of the bond
in a contract and are a fixed contractual commitment
how often do bonds pay interest or the coupon
semin-annually or annually and full principal payment at maturity
what is a bullet payment or balloon payment
- when the principal payment is made in one lump sum at maturity
what are bonds sometimes refered to as and why
fixed income securities
- because the interest payments and principal repayment are specified, or fixed at the time the bond is issued
if the buyer decides to sell the bond before maturity what happens to the price received
the price recived will depend on the level of interest rates at that time
How is a bond’s structure different from a loan or mortgage
- beause it had blended payments (principal and interest)
a bond can be viewed as 2 separate components what are they
- an annuity (consisting of identical and regular interest payments)
- a lump sum payment a maturity
what is a bond indenture
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
what is collateral
assets that can serve as security for the bond in case of default
what are covenant provisions
clauses within the indenture that lay out the legal rights of the bondholder and the obligations of the issuer
what is par value
also called face value or marturity value
- amount paid at marturity
what is term to maturity
time remaining to maturity date
what are interest payments or coupons
amounts paid on a bond at regular intervals
what is the par value on most bonds
$1,000
although bond prices are typically quoted on par value of 100
if the price of a bond is quoted at $99,583, a $1,000 par value bond would be selling at what
$995.83
How are interest payments or coupons determined
by multiplying coupon rate (stated on annual basis) by par value of the bond
a bond with a coupon rate of 6% and a par value of $1,000 would pay a coupon of
$60 annual or $30 every 6 months
what are mortgage bonds
debt instruments that are secured by real assets
- not all bonds are secured by real property
what are debentures
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)
what are some examples of debentures
gov bonds, because no specific security is pledged as collateral
- called bonds as a matter of convention
what are collateral trusts and bonds secured by
a pledge of other financial assets
such as common shares, bonds or treasury bills
what are equipment trust certificates
a type of debt instrument secured by equipment
- such as railway rolling stock
what are protective covenants
clauses in the trust indentrue that restricts the actions of the user
- negative covenants
- positive covenatns
what are negative covenants
restrict certain actions
- restrict a company form making a dividend payment over a ceratin amount
- or prevent them from pledging assets to another lender
what are positive covenants
specify actions that the firm agrees to undertake
- company may promise to provide quarterly f.s. or maintain certain working capital levels
what are some bond features or options
- callable bonds, call prices, retractable bonds, extendible bonds, sinking fund provisions, purchase fund provisions, convertible bonds
what is a callable bonds
bonds that give the issuer the option to “call” or repurchase, outstanding bonds at predetermined prices at specified times
what are call prices
generally at a premium over par, at which issuers can repurchase bonds
what are retractable bonds
bonds that the bondholder can sell back to the issuer at a predetermined prices at specified times earlier than the maturity date
what are extendible bonds
bonds that allow the bond holder to extend the maturity date of the bonds
what are sinking fund provisions
the requirement that an issuer set aside funds each year to be used to pay off the debt at maturity
what are purchase fund provisons
the requirement that a certain amount of debt be repurchased only if it can be repurchased at or below a given price
what are convertible bonds
bonds that can be converted into common shares at predetermined conversion prices
how do you determine the price of a bond and what do you need to know
- 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)
what are the factors that affect the discount rate
- function of market conditions (ie other market interest rates)
- factors specific to issue and issuer
what is the price of the bond
the PV of the future, which is the PV of the interest payments and the par value repaid at maturity
what is a discount
difference b/w a bond’s par value and the price it trades at when it trades below the par value
if the coupon rate is less than the market interest (discount) rate what is the bond trading at
a discount
because coupon rates are fixed, the only way to get a higher return is to
pay less than par value for it
what is par value
when market rate = coupon rate
what is premium
when market interest rates are below coupon rate
what are the factors affecting bond prices
1, interest rates
relationship b/w market rates and bond prices
3. relationship b/w coupon rate an dbond’s ytm
if interest rates decrease
market prices of bonds increase and vice versa
the relationship between market rates and bond prices is
not linear; the curve is convex
interest rates are inversely related to bond prices
bond prices increase when interest rates decrease and vcie versa
the relationship b/w the coupon rate and the bond’s YTM
determines if the bond will sell at a premium or a discount or par
if the coupon rate is greater than YTM
price is greater than face value = discount
if coupon rate = YTM
price = face value , par
if coupon rate Iess than YTM
prices is less than Face value = Preimum
what are the factors that affect bond prices
- YTM
- time to maturity
- size of coupon
- interest rate risk and duration
what affects the volatility of a bond
YTM, time to maturity and size of coupon
how does time to maturity affect a bond
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
how does the size of the coupon affect the bond
low coupon bonds have greater price volatility than high coupon bonds
what do high coupon bonds act like
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
how does interest rate risk and duration affect the bond
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
the impact of interest rate risk is measured using
duration
duration measures
of interest rate risk as a change in price for a given change in interest rates
a bond’s duration will be higher if its:
- YTM is lower
- Term to maturity is longer
- coupon is lower
what is the quoted price
the price quoted by the media
what is the cash price
the price paid by an investor
- includes both the quoted price plus any interest that has accrued since the last coupon payment date
what is YTM an investor would earn if
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)
YTM is what
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
what is the YTM on a 6% semi-annual coupon bond with 20 years to maturity that is selling for $1,030
(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
what is the YTC yield to call
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
callable bonds are initially protected from what
from call for a period of a few years (5,7, or 10)
- after which the issuer can call the bond
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
30 PMT -1030 PV 1050 FV N 10 CPT I/1 = 3.081% semi - annual rate x 2 to annualize = 6.16% annual YTC
when the call price is above the current market price (regarding callable bonds)
unlikely to be called back by the issuer
- therefore it is selling based on its YTM not YTC
the bond would trade on its YTM if (regarding callable bonds0
it was likely the bond would be called
- occur if the bond were trading above its call price
how does the bond usually trade off for callable bonds
whichever is lower, the
what is the current yield
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
what is the current yield also called
the flat or cash yield
what is the formula for Current yield
CY = annual interest / B
determine the current yield for a bond with a 5.5% coupon and a current market price of $1,050
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
if a bond trades at a premium the CY
the CY will be less than the coupon rate
- but cy grater than the YTM
if a bond trades at a discount the CY
the cy will b e greater than the coupon rate but less than the YTM
par value the coupon rate
coupon rate = cy= ytm
discount the coupon rate
is less than CY and CY than tan YTM
premium the coupon rate
is is greater than CY and CY is greater than YTM
