Chapter 7 Flashcards
Which market is used by to get long-term funds in order to finance capital investments and expansion projects?
The capital market (Bond and equity markets)
Which 2 markets make up the capital market?
(Bond and Long-term debt markets) and equity markets
What advantages are there to the investor with a zero-coupon bond?
No reinvestment risk. More volatile
Where are bonds and long-term debt instruments traded?
On exchanges and OTC
Are international bond markets usually OTC or exchange traded?
They are usually traded OTC but should move to exchanges
What is a bond?
A bond is a fixed-interest-bearing security sold by the issuer promising to pay the holder interest at future dates and the nominal value at maturity
In what denominations are bonds usually issued?
Usually in multiples of R1 million
What is the maturity range of bonds?
1 - 30 years
What is the quality of bonds?
They are considered to be risk-free if issued by the government. Else they quality of corporate bonds depends on the issuer.
What are the advantages of bonds?
Issuer: The interest cost of fixed-rate bonds is fixed over the life of the bond
Investor: Large selection in terms of maturity. Liquid secondary market.
What are the disadvantages of bonds?
Issuer: If market rates fall after the fixed-rate bond has been issued, the issuer is locked into paying interest rates above market rates
Investor: Can incur capital loss if interest rates increase. But only if sold before maturity
What are debentures?
It is an interest-bearing security issued by a company
In what denominations are debentures usually issued?
Multiples of R1 million
What is the usual maturity range of debentures?
5 - 30 years
What are the advantages of debentures?
Issuer: If the debenture has a fixed-rate, the interest cost is fixed over the life of the debenture. This helps with planning and budgeting for capital projects.
Investors: Terms and conditions may be favourable
What are the disadvantages of debentures?
Issuer: If the debenture has a floating rate and interest rates rise, then greater costs may be incurred.
Investor: Investors are exposed to credit risk. If it has a floating rate then the investor is exposed to interest-rate risk.
What is a floating rate note?
It is a debt security for which the coupon is re-fixed periodically ( usually 6 months )
What denominations are floating rate notes usually issued in?
They are usually issued in multiples of R1 million
What is the usual range of maturity of floating rate notes?
5 - 30 years
What are the advantages of floating rate notes?
Issuer: If short-term rates decrease after issuance, the issuer may fund at a rate lower than that of a fixed-rate loan
Investor: Coupons are adjusted to reflect general movements in interest rates which gives investors protection against significant capital losses. If short-term interest rates are high is could be attractive to investors.
What are the disadvantages of floating rate notes?
Issuer: Interest rates could rise making the issuer pay more than a fixed-rate bond
Investor: Less opportunity for capital gains than with fixed-rate investments. Could also have credit risk.
What is a zero-coupon bond?
It is a bond that pays no coupons. They are purchased at a discount
In what denominations are zero-coupon bonds usually issued?
In multiple of R1 million, but zero coupon bonds derived from a strip may be less.
What is the usual maturity range for zero-coupon bonds?
5 - 30 years
What are the advantages of zero-coupon bonds?
Issuer: The interest cost is fixed over the life of the bond. Issuer does not have to make payments until maturity of the bond
Investor: No reinvestment risk. More volatile than conventional bonds
What are the disadvantages of zero coupon bonds?
Issuer: If interest rates fall then the issuer is locked into “paying” higher rates
Investor: No reinvestment risk which is bad when rates are rising. Investors are exposed to credit risk (unless issued by government)
By who is the majority of bonds issued in South Africa?
Majority of the bond traded in South Africa are issued by the national government
Why does corporates issue bonds?
To borrow money directly from the public.
Who are the investors in the bond market?
Institutional investors such as insurance companies and pension funds.
