Chapter 7: Interest Rates and Bond Valuation

Question 1

• Coupon-

Answer 1

the stated interest payment made on a bond

Question 2

• Face value or par value

Answer 2

• the principal amount of a bond that is repaid at the end of the term

Question 3

• Coupon rate-

Answer 3

the annual coupon divided by the face value of a bond.

Question 4

Maturity -

Answer 4

specified date at which the principal amount of a bond is paid.

Question 5

• Yield to maturity (YTM)–

Answer 5

the market interest rate the equates a bond’s present value of interest payments and principal repayment with its price.

Question 6

• Discount bond–

Answer 6

a bond that sells less that its face value.

Question 7

Premium bond–

Answer 7

a bond that sells for more than its face value

Question 8

Interest Rate Risk

Answer 8

• The risk that arises for bond owners from fluctuating interest rates (market yields)
○ All other things equal, the longer the time to maturity, the greater the interest rate risk
All other things equal, the lower the coupon rate, the greater the interest rate risk.

Question 9

Equity securities and debt securitites–>

Answer 9

securities issue by corporations

Question 10

• Debt secures are called:

Answer 10

○ Notes
○ Debentures
Bonds–> secured debt securities.

Question 11

• Two major forms of long-term debt are

○

Answer 11

Public issued

Privately place

Question 12

Main difference between the two is

Answer 12

that privately placed are given to certain people and not offered to the public.

Question 13

Indenture-

Answer 13

• written agreement between the corporation and the lender detailing the terms of the debt issue. Important because it contains

Question 14

Corporate bonds are usually in registered form–

Answer 14

retail market of company records ownership of bond; payment is made directly to the owner of the record

Question 15

§ Bearer form-

Answer 15

-bond issued without record of the owners name; payment is made to whoever holds the bond.
□ Difficult to recover is stole or lost
Corporation doesn’t know who owns the bonds, they can not notify them of important events.

Question 16

§ Collateral

Answer 16

– securities pledged as security for payment of debt.

Question 17

§ Mortgage securities-

Answer 17

• secured by a mortgage on the real property of the borrow

Question 18

§ Debenture-

Answer 18

• unsecured debt, usually with a maturity of ten years or more.

Question 19

Note-

Answer 19

unsecured debt, usually with a maturity under ten years.

Question 20

Sinking fund-

Answer 20

• account managed by the bond trustee for early bond redemption

Question 21

○ The call provisions

Answer 21

§ – agreement giving the corporation the option to repurchase the bond at a specified price before maturity.

Question 22

§ Call premium–

Answer 22

amount by which the call price exceeds the par value of the bond

Question 23

§ Deferred call-

Answer 23

call provision prohibiting the company from redeeming the bond before a certain date

Question 24

§ Call protected–

Answer 24

bond during period in which it cannot be redeemed by the issuer

Question 25

Canada plus call–

Answer 25

call provision that compensates bond investor for interest differential, making it unattractive for an issuer to call a bond

Question 26

Protective covanant–

Answer 26

part of the indenture limiting certain transactions that can be taken during the term of the loan, usually to protect the lender’ ear interest.

Question 27

two types of protective covenants

Answer 27

positive

negative

Question 28

□ Negative–>

Answer 28

“thou shalt not”- limits or prohibits actions that the company may take

Question 29

Positive-

Answer 29

” thou shalt”- specifies an actions that the company agrees to take or a condition the company must abide by

Question 30

• A trustee is appointed by the corporation to represent the bondholds. They must

Answer 30

○ Make sure the terms of the indenture are obeyed
○ Manage the sinking fund
Represent the bond holders in default (if company does make payments.

Question 31

• Financial engineering

Answer 31

– when financial managers or their investment bankers design new securities or financial processes
○ Reduces and controls risk, and minimizes taxes
Reduces financing costs of issuing and servincing dent as well as costs of complyingg with rules laid out by regulatory authorities

Question 32

Stripped bonds

Answer 32

A bond that makes no coupon payments, thus initially priced at a deep discount.

Question 33

• Floating rate bonds–

Answer 33

bonds that have coupon rate that can be adjusted. The adjustments are tied to the Treasury bill rate or another short-term interest rate. Issued to control the fluctuations in inflation.

Question 34

Income bonds

Answer 34

are similar to conventional bonds, expect that coupon payments depend on company income. Payments are made if company is making money

Question 35

Convertible bond–

Answer 35

can be swapped for a fixed number of shares of stock any time before maturity. At the holder’s option.

Question 36

Asset-backed bonds-

Answer 36

are backed by a diverse pool of illiquid assets such as accounts receivable collections, credit card debt, or mortgages

Question 37

Retractable bonds-

Answer 37

bond that may be sold back to the issuers at a presepecified price before maturity.

Question 38

• Clean price-

Answer 38

the price of a bond net of accrued interest; this is the price that is typically quoted.

Question 39

Dirty price-

Answer 39

the price of a bond including accrued interest, also known as the full or invoice price. This is the price the buyer actually pays.

Question 40

Bond fund-

Answer 40

is a mutual fund that invests in bonds and other debt securities.

Question 41

The fisher Effect

Answer 41

• The relationship between nominal returns, real returns, and inflations
	• 1+R=(1+r)*(1+h)
		○ R- nominal rate
		○   r - real rate
H-inflation rate

Question 42

• Term structure of interest rates–

Answer 42

the relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money.

Question 43

Interest rate risk premium -

Answer 43

the compensation investors demand for bearing interest rate risk

Question 44

• Inflation premium

Answer 44

• the portion of a nominal interest rate that represents compensation for expected future inflation

Question 45

• Canada yield curve – maturity.

Answer 45

a plot of th yields on Government of Canada notes and bonds relative to

Question 46

• Default risk premium-

Answer 46

the portion of a nominal interest rate or bond yield that represents compensation for the possibility of default.

Question 47

Liquidity premium-

Answer 47

the portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity.