Chapter 7: Interest Rates and Bond Valuation Flashcards
• Coupon-
the stated interest payment made on a bond
• Face value or par value
- the principal amount of a bond that is repaid at the end of the term
• Coupon rate-
the annual coupon divided by the face value of a bond.
Maturity -
specified date at which the principal amount of a bond is paid.
• Yield to maturity (YTM)–
the market interest rate the equates a bond’s present value of interest payments and principal repayment with its price.
• Discount bond–
a bond that sells less that its face value.
Premium bond–
a bond that sells for more than its face value
Interest Rate Risk
• 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.
Equity securities and debt securitites–>
securities issue by corporations
• Debt secures are called:
○ Notes
○ Debentures
Bonds–> secured debt securities.
• Two major forms of long-term debt are
○
Public issued
Privately place
Main difference between the two is
that privately placed are given to certain people and not offered to the public.
Indenture-
- written agreement between the corporation and the lender detailing the terms of the debt issue. Important because it contains
Corporate bonds are usually in registered form–
retail market of company records ownership of bond; payment is made directly to the owner of the record
§ Bearer form-
-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.
§ Collateral
– securities pledged as security for payment of debt.
§ Mortgage securities-
- secured by a mortgage on the real property of the borrow
§ Debenture-
- unsecured debt, usually with a maturity of ten years or more.
Note-
unsecured debt, usually with a maturity under ten years.
Sinking fund-
- account managed by the bond trustee for early bond redemption
○ The call provisions
§ – agreement giving the corporation the option to repurchase the bond at a specified price before maturity.
§ Call premium–
amount by which the call price exceeds the par value of the bond
§ Deferred call-
call provision prohibiting the company from redeeming the bond before a certain date
§ Call protected–
bond during period in which it cannot be redeemed by the issuer
Canada plus call–
call provision that compensates bond investor for interest differential, making it unattractive for an issuer to call a bond
Protective covanant–
part of the indenture limiting certain transactions that can be taken during the term of the loan, usually to protect the lender’ ear interest.
two types of protective covenants
positive
negative
□ Negative–>
“thou shalt not”- limits or prohibits actions that the company may take
Positive-
” thou shalt”- specifies an actions that the company agrees to take or a condition the company must abide by
• A trustee is appointed by the corporation to represent the bondholds. They must
○ Make sure the terms of the indenture are obeyed
○ Manage the sinking fund
Represent the bond holders in default (if company does make payments.
• Financial engineering
– 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
Stripped bonds
A bond that makes no coupon payments, thus initially priced at a deep discount.
• Floating rate bonds–
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.
Income bonds
are similar to conventional bonds, expect that coupon payments depend on company income. Payments are made if company is making money
Convertible bond–
can be swapped for a fixed number of shares of stock any time before maturity. At the holder’s option.
Asset-backed bonds-
are backed by a diverse pool of illiquid assets such as accounts receivable collections, credit card debt, or mortgages
Retractable bonds-
bond that may be sold back to the issuers at a presepecified price before maturity.
• Clean price-
the price of a bond net of accrued interest; this is the price that is typically quoted.
Dirty price-
the price of a bond including accrued interest, also known as the full or invoice price. This is the price the buyer actually pays.
Bond fund-
is a mutual fund that invests in bonds and other debt securities.
The fisher Effect
• The relationship between nominal returns, real returns, and inflations • 1+R=(1+r)*(1+h) ○ R- nominal rate ○ r - real rate H-inflation rate
• Term structure of interest rates–
the relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money.
Interest rate risk premium -
the compensation investors demand for bearing interest rate risk
• Inflation premium
- the portion of a nominal interest rate that represents compensation for expected future inflation
• Canada yield curve – maturity.
a plot of th yields on Government of Canada notes and bonds relative to
• Default risk premium-
the portion of a nominal interest rate or bond yield that represents compensation for the possibility of default.
Liquidity premium-
the portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity.
