Chpt 2 Debt

Question 1

What are 3 types of bond maturity structures?

Answer 1

Term Maturity “Term Bond”: principal of the whole issue matures at once.
Serial Maturity “Serial Bond Issue”: portions of the principal to mature at intervals over a period of years until the entire balance has been repaid.
Balloon Maturity: Issuer repays part of the principal before maturity but, pays off the major portion of the bond at maturity

Question 2

What form must a bond be in for an investor to receive interest and principal payments by mail?

Answer 2

Bonds must be fully registered or in book-entry form.

Question 3

If one point equals $10 (i.e. $1000 x 1%), one basis point equals?

Answer 3

1000 x .0001 = $0.10

Question 4

Rating services like Standard & Poor’s (S&P) and Moody’s, evaluate the credit quality of which type of bonds?

Answer 4

corporate and municipal bonds

Question 5

What valuations does Standard & Poor’s (S&P) and Moody’s use for their ratings?

Answer 5

S&P; bond either falls within top (+) or bottom (-) of a category (i.e. AA+ or A-)
Moody’s; numerical qualifiers to their categories (i.e. Aa1 or Baa2) - lower the number the higher the rating within the category.

Question 6

Below which S&P and Moody rating would a bond be considered speculative?

Answer 6

BBB / Baa

Question 7

What is the safest type of debt security?

Answer 7

US Government Securities (i.e. Treasury bills, notes, bonds, and saving bonds)

Question 8

What is the riskiest type of debt security?

Answer 8

Corporate Debt Security

Question 9

Liquidity is interchangeable with what other term?

Answer 9

Marketability

Question 10

Do highly rate issuers establish sinking funds?

Answer 10

No, lower rated issuers do to make their issues more marketable.

Question 11

When do issuers call bonds?

Answer 11

Calls occur when interest rates are declining.

Question 12

Investors who purchase callable bonds face what types of investment risk?

Answer 12

Call risk; risk that bonds will be called and the investor will lose the stream of income from the bond. Reinvestment risk; if interest rates are down when the call takes place, what likelihood does the investor have of investing the principal received at a comparable rate?

Question 13

How much interest does a bond receive once called?

Answer 13

bonds do not pay interest after they have been called

Question 14

Define Refunding Bonds.

Answer 14

Raising money to call a bond – issuer sells a new bond to generate funds to retire an existing bond approaching maturity.

Question 15

When does pre-refunding occur? What does it lock in?

Answer 15

When there is a call protection. The issuer cannot legally call the bonds until a future date, but if interest rates are low, a low rate can be locked in by issuing the new bonds in advance of the call date.

Question 16

Are prefunded bonds risky?

Answer 16

No, they cannot get any safer (AAA).

Question 17

Funds from a pre-funded bond is escrowed into what type of security?

Answer 17

Government securities

Question 18

Putable bonds are commonly found in what type of bond?

Answer 18

Municipal bonds

Question 19

Once putable, what type of risk if the investor protected against?

Answer 19

market risk (interest rate risk) as the bonds, at that point, will not trade much below the put price, which is par.

Question 20

What equation is used to find Current Yield (CY)?

Answer 20

Current Yield = annual interest / Market price

Question 21

Describe the relationship between Coupon Yield and Current Yield during premium, par, and discount.

Answer 21

When bonds are at par; coupon and CY are equal. When bonds are at premium; CY < Coupon. When bonds are at discount; CY > coupon

Question 22

Answer the following:
If a bond has a YTC < CY, it is trading at
If a bond has YTM and CY that are equal, bond is trading at
If a bond has a YTM < YTC, it is trading at
If a bond has YTM > coupon, it is trading at

Answer 22

Premium
Par
Discount
Discount

Question 23

Rank yields from highest to lowest for Premium.

Answer 23

Nominal
CY
YTM
YTC

Question 24

Rank yields from highest to lowest for Discount.

Answer 24

YTC
YTM
CY
Nominal

Question 25

An economic expansion is reflect with which type of Yield Curve? Do interest rates decrease?

Answer 25

Normal “Positive” Yield Curve

No, it predicts interest rates will rise

Question 26

Are long term interest rates higher or lower than short term rates on the Inverted “Negative” Yield Curve?

Answer 26

lower

Question 27

What is expected if the Yield Curve spread between corporate bonds and government bonds is widening?

Answer 27

Recession - Investors have chosen the safety of government bonds over higher corporate yields, which occurs when the economy slows down.

Question 28

What is expected if the Yield Curve spread between corporate bonds and government bonds is narrowing?

Answer 28

Economic expansion - investors are willing to take risks. They will sell government bonds to buy higher-yielding corporates.

Question 29

As interest rates change, long-term bonds move more in ____ than short-term.

Answer 29

Price

Question 30

If two discount bonds have the same time to maturity, which will appreciate the most if rates fall?

Answer 30

The bond trading at the deeper discount (i.e. the one with the lower coupon).

Question 31

If two callable bonds have the same time to maturity, which will appreciate the most if rates fall?

Answer 31

The bond with the most distant call date

Question 32

What are three secured bonds?

Answer 32

Mortgage bond
Collateral Trust Bond
Equipment Trust Certificate

Question 33

What are two classifications of unsecured bonds?

Answer 33

Debentures

Subordinated Debentures

Question 34

Do Income Bonds pay interest?

Answer 34

No, they only pay face value.

Question 35

Do Zero-Coupon Bonds pay tax?

Answer 35

Yes, investor’s owe income tax each year on the amount by which the bonds have accreted

Question 36

Choose the security that has no reinvestment risk.

Answer 36

Zero-Coupon Bond because with no interest payments to reinvest, the investor has no reinvestment risk. Furthermore, because there is no reinvestment risk, buying a zero is the only way to lock in a rate of return.

Question 37

What is a trust indenture?

Answer 37

legal a contract between the issuer and the trustee for the benefit of the bondholders

Question 38

Corporate bonds trade on which platform?

Answer 38

NYSE and OTC

Question 39

Provide the equation for how to find the conversion price, conversion ratio, parity price of common stock, and parity price of convertible bond.

Answer 39

Conversion Price = Par Value / # shares
Conversion Ratio (“# shares”) = Bond par value / Conversion price per share
Parity price of Common Stock = [Market price of bond / Conversion ratio (# of shares)]
Parity price of Convertible Bond = Market price of common x conversion ratio

Question 40

What is the equation for calculating the new conversion price when a stock dividend is received?

Answer 40

(Conversion price) / (100% + % increase) = new conversion price

Question 41

What are 3 marketable government securities?

Answer 41

Treasury Bill
Treasury Note
Treasury Bond