Debt Flashcards
Bond
Debt security that obligates the issuer to pay interest semi-annually and repay the principal amount when the debt matures.
Par Value
Amount bonds are issued at. Most are at $1,000
Redemption
Issuer pays back interest and principal
Term Bond
Bond issue where every bond has the same interest rate and maturity.
Serial Bond
A bond issue with differing maturities and different interest rate.
Balloon maturity
A large section of bonds maturing at the same time in a serial bond.
Series bond
A bond issue where the bonds have the same maturity but different dates of issuance. generally used in construction projects. Total interest cost to issuer reduced this way.
Corporate Bond quoted in
A percentage of par in 1/8ths
Government/treasury bond quoted in
a percentage of par in 1/32nds
Municipal Bonds quoted in
Basis quotes or yields (YTM)
One basis point =
.01%
5.50% at 6.00 means
A bond with a current yield of 5.50% is quoted at a 6.0% YTM or basis.
Dollar Bonds
Term Bonds for corporate, government, or Municipal bonds. Any bond quoted on a percentage of par basis (not on a yield basis).
Price at Discount
Amount of interest received is less than current market interest.
Price at Premium
Amount of interest received is more than current market interest.
Formula for approximate price of long term bond quoted on a yield basis
Coupon rate/basis to get percent of par of the price.
Discount Bond
A bond sells at a discount when par value is in excess of the bond’s purchase price.
Premium Bond
A bond sells a a premium when the bond’s purchase price is in excess of par value.
PNCYY
Price, Nominal Yield, Current Yield, Yield to Maturity, Yield to put or call
Greater volatility
Longer maturity, lower coupon, large discount
Lower volatility
shorter maturity, higher coupon, small discount
Most volatile bonds
Long term zero bond issues
Nominal Yield
Stated rate of interest on the bond
Current Yield formula
Annual Interest in Dollars/Bond’s Market Price
Yield to Maturity formula
(annual income + or - capital gain/loss)/((purchase price + Redemption Price)/2)
Call definition
An issuer has the right to redeem (call) the bond at a predetermined price at a date prior to maturity.
When do calls occur
When interest rates drop. The company can call the bonds and re-distribute the bonds at a lower interest rate.
Call protection
Bonds can’t be called for a certain number of years so investors will buy them and have some protection. Typically 10 years.
Does call price set a ceiling or a floor on market price?
Ceiling.
How are zero coupon bonds callable?
At accreted value plus the call premium.d
Put definition
Gives the investor the right to tender the bond (put the bond) to the issuer after a specified date for a price set in the bond contract.
When does an investor exercise a put?
When interest rates rise. The bonds become less valuable.
Does put price set a ceiling or a floor on market price?
Floor.
Yield to Call or Put formula
(annual income + or - annual capital gain or loss)/((purchase price + call or put price)/2)
Credit Risk
The risk that the issuer cannot make interest and principal payments on an issue. Ratings agencies only rate bonds for credit risk.
Agencies that rate bonds
Moody’s, Standard and Poors, Fitch’s
Treasury debt rating is
always AAA. The government doesn’t default on payment.
Standard and Poor Investment Grade
AAA, AA, A, BBB, + and -
Standard and Poor Speculative Grade (junk)
BB, B, CCC, CC, C, + and -
Moody’s Investment Grade
Aaa, Aa, A, Baa, 1-2-3
Moody’s Speculative Grade (junk)
Ba, B, Caa, Ca, C, 1-2-3
Standard and Poor’s commercial paper ratings
P1, P2, P3, NP (only P1 and P2 are traded)
Standard and Poor’s Municipal note ratings
MIG 1, MIG 2, MIG 3, SG (investment grade MIG1, MIG2)
Interest Rate Risk/Market Risk
The risk that rising interest rates will cause pond prices to fall. Long term, low coupon, and deep discount bonds are more susceptible to this. Only applies to fixed rate securities.
Purchasing Power Risk
The risk that inflation will lower the value of bond interest payments and principal repayment, thereby forcing prices to fall. most significant for long term bonds when market interest rates rise.
Marketability Risk
The risk that the security will be difficult to sell.
Liquidity Risk
The risk that the security can only be sold by incurring large transaction costs.
Legislative Risk
The risk that new laws reduce the value of a security.
Call Risk
The risk that the bonds may be redeemed prior to maturity, forcing reinvestment of the proceeds at lower interest rates.
Reinvestment Risk
The risk for a long-term bond investor that market interest rates are falling over that investment’s time horizon and the reinvested interest rates will be lower.
What security avoids reinvestment risk?
Zero coupon bond
Exchange Rate Risk
The risk that the value of the currency in which the investment is denominated weakens (or the U.S. dollar strengthens).
Political Risk
Risk of investing in foreign countries that have weak political and legal systems-typically 3rd world countries.
Normal Yield Curve
Ascending. Typical during periods of economic expansion. Monetary policy is loose.
