Chapter 7

Question 1

Bond

Answer 1

When a corporation wishes to borrow money from the public long-term basis, it usually issues or sells debt securities called bonds

Question 2

Coupon

Answer 2

Interest payments are called the bond’s coupons. Because the coupon is constant and paid every year, this type of bond is also called: level coupon bond

Question 3

Coupon rate

Answer 3

The annual coupon amount divided by the face value is called the coupon rate of the bond

Question 4

Time to maturity

Answer 4

Number of years until the face value is paid

Question 5

Change of interest rate and value of bonds

Answer 5

When interest rate rises, PV of the bond’s cash flow goes down.

When interest rate decreases, PV of the bond’s cash flow goes up.

Question 6

Bond value formula

Answer 6

Bond value = present value of coupons + present value of face amount

C/r * (1-(1/(1+r)^t)) + FV/(1+r)^t

Question 7

Discount bond

Answer 7

When a bond is sold for less than its face value it is said to be discounted bond

Question 8

Premium bond

Answer 8

Bond sold at premium, more than its face value is called premium bond

Question 9

Bond price and market interest rate relationship

Answer 9

Bond price and market interest rate move in opposite directions.
The risk of bond’s price change arises from fluctuating market interest rate.

Question 10

Time to maturity, coupon rate and the interest rate

Answer 10

1. All other things being equal, the longer the time to maturity, the greater the interest rate risk.
2. All other things being equal, the lower the coupon rate (and larger the face value), the greater the interest rate risk.

Question 11

Debt and equity

Answer 11

Equity and debt: securities issued by corporations are classified roughly as equity securities and debt securities.

Dept isn’t an ownership interest in the firm. Creditors generally do not have voting power.
The corporation’s payment of interest on debt is considered a cost of doing business and is fully tax deductible. Dividends are not tax deductible.
Unpaid debt is a liability of the firm. If not paid, creditors can legally claim the assets of the firm.

Question 12

What does bond generally include?

Answer 12

Face value, coupons, maturity…
Registration: corporate bonds are usually in registered form; the ownership of each bond is recorded.

Question 13

Security

Answer 13

Debts can be backed by specific assets of the issuer to secure the payment of interest and the repayment of the principal - collaterals.

Question 14

Seniority

Answer 14

It is the hierarchy among different bonds outstanding in terms of their priority of repayment in the event of a default or bankruptcy. It has a higher priority than another bond’s claim.

Question 15

Protective covenants

Answer 15

It’s a part of the indenture that controls certain actions of the issuer company may take to protect the lenders’ interests.

Question 16

Bond ratings

Answer 16

Later-based system to evaluate creditworthiness: highest rating is AAA/Aaa; very good quality is AA/Aa; investment grade bonds are rated at least BBB; low-grade or “junk” bonds are rated below investment grade

Question 17

Government bonds

Answer 17

When the government wishes to borrow money for more than one year, it sells treasury notes and bonds to the public

Question 18

Zero coupon bonds

Answer 18

A bond that pays no coupons at all, however its price is lower than its face value

Question 19

Floating-rate bonds

Answer 19

The conventional bonds have fixed obligations because the coupon rates and the face value are fixed. The payments of floating-rate bonds are tied to a predetermined index.

Question 20

The fisher effect

Answer 20

The relationship between nominal returns, real returns and inflation

1+R=(1+r)(1+h)
R=r+h+rh

Question 21

Term structure of interest rates

Answer 21

When long-term rates are higher than short-term rates, we say that the term
structure is upward sloping.
When short-term rates are higher, we say it is downward sloping.

Question 22

Bond yields

Answer 22

(1) expected future inflation
(2) interest rate risk
(3) default risk
(4) taxability
(5) lack of liquidity.