Debt Securites

Question 1

Essentially, what is a bond ❓

Answer 1

A bond is a loan to a company or government.

Question 2

❓ Fill in the blank:

Stockholders are (part) owners of a company as bondholders are ______ of a company.

Answer 2

Creditors

Question 3

What are the benefits of a company issuing a bond ❓

Answer 3

Bonds allow companies to borrow money on their terms, they choose the maturity date, scheduled interest payments, coupon rate, and so on. This is better than borrowing from a lending institution.

Question 4

❓List the common bond issuers from least risky to most risky -

Answer 4

Corporate (most risky)
Municipal
U.S Government (least)

Question 5

Bond terminology - Maturity❓

Answer 5

Maturity refers to the date the bondholder will get paid PAR value (plus any interest).

Question 6

Bond terminology - PAR value❓

Answer 6

PAR is a bookkeeping value that reflects the face value or denomination of a bond.
PAR value is expressed in a percentage of $1000 (usually unless otherwise specified)

For example, a bond at 90 par is worth $900, or a bond at 110 par is worth $1100

Side Note - Corporate bonds are usually quoted in increments of 1/8% or .00125.
For example, a bond trading at 99 3/8 is equal to 99.375% and would be trading at $993.75

Question 7

When a bond is listed as the following, how is this translated❓
ABC company 7.50s 2035 was at 101

Answer 7

ABC company bond with a coupon rate of 7.5% maturing in 2035 last traded for 101 PAR ($1010)

Question 8

Bond terminology - Coupon rate ❓

Answer 8

Refers to the interest (rate) which determines the yield (interest to be paid)

Question 9

Bond terminology - Yield ❓

Answer 9

The yield is the interest paid based on the coupon rate; the yield is calculated by dividing the coupon rate % by 100 followed multiplying that number by the PAR value ($1000).

Ex: 5.5% coupon rate would pay out $55 per share

(5.5%/100 = 0.055 x 1000 = $55)

Question 10

❓ Fill in the blank:

Stocks pay dividends like bonds pay ____

Answer 10

Interest

Question 11

Bond terminology - Indenture document ❓

Answer 11

Also known as ‘deed of trust’ or ‘resolution’; cites important information about the agreement between the issuer and the bond holder including;
Maturity date
PAR
Coupon rate and payment dates
Collateral (sometimes!)
Any callable or convertible features
Name of trustee who sees to the bond holder rights

Question 12

Maturity schedule - Term bonds ❓

Answer 12

✅Bonds issued all at the same time with the same maturity date (pay date)
✅Corporations that issue this type of bond have what is called a ‘sinking fund’.

Fund with money set aside to pay back creditors. Usually, a good thing creditors like to see so the issuer does not default (not pay back interest or par value at maturity)

Question 13

What is the time frame for a bond to be considered a Short-Term❓

Answer 13

✅ 3 years or less - short term

Question 14

What is the time frame for a bond to be considered a Medium-Term❓

Answer 14

✅ 3-10 years - medium term

Question 15

What is the time frame for a bond to be considered a Long-Term❓

Answer 15

✅ 10+ years - long term

Question 16

Maturity schedule - Series bonds

Answer 16

✅ Bonds issued in successive years with only one maturity date, usually by construction companies and not common.

Question 17

Maturity schedule - Serial bond

Answer 17

✅Bonds that mature on regular intervals
Ex- ABC corp issues $10 million in bonds with 25% maturing in the next 5 years or 5% maturing yearly.
✅These bonds are usually issued to fund projects that bring income streams in.
✅Common for municipalities to issue serial bonds.

Question 18

What is a ballon issue?

Answer 18

✅ Serial bond issued with several maturing at the end of the maturity date.

Question 19

Define secure vs unsecured bond

Answer 19

✅ Secured bond is backed by collateral-like property; considered safer but payout less interest. (Lower coupon rate)
✅ Unsecured bonds are not backed by anything, considers risky but have the benefit of higher interest (higher coupon rate)

Question 20

Secured Bond - Mortgage (two flavors)

Answer 20

✅ Backed by property, comes in two flavors.

Open ended - Issuer can borrow more money using the same property to back the new debt.

Closed ended - they can’t do that.

Question 21

Secured Bond - Equipment trusts

Answer 21

✅ Bonds backed by the sale of company equipment. Trustee is in charge of selling off to pay creditors.

Question 22

Secured Bond - Collateral trusts

Answer 22

✅ Bonds backed by assets such as stocks or bonds they own. Trustee would sell to pay off creditors.

Question 23

Secured Bond - Guaranteed bonds

Answer 23

✅ Bonds backed by a firm other than the issuer like a parent company. The parent company would be considered the ‘Grantor’ and is responsible for paying back. Their credit rating is used when issuing bonds instead of the issuing company.

Question 24

Unsecured Bond - Debentures

Answer 24

✅ Unsecured bond type that is backed by the company’s good word and credit rating. Company promises they will pay interest annual and semiannual along with the PAR at maturity.

Question 25

Unsecured Bond - Income (adjusted) bonds

Answer 25

✅ Unsecured bond type considered the riskiest, usually issued at deep discounts like $500 for 1000 par. Company promises to pay back only if earnings are high enough. Not recommended if risk averse.

Question 26

What is the relationship between bond price and the coupon rate?

Answer 26

✅ As the coupon rate goes down, the price of the bond goes up. ✅ As the coupon rate goes up, the bond price goes down.

Question 27

Nominal yield (coupon rate yield)

Answer 27

✅ The assumed return (interest) for the life of the bond IF the rate stayed fixed. The yield is calculated by multiplying the percentage as a decimal by the PAR dollar value (1000). Ex- bond with a coupon rate of 5% (0.05) has a nominal yield of $50 (0.05 x $1000 = $50 nominal yield)

Question 28

Current yield (CY)

Answer 28

✅ Is the current interest rate based on the current market price (PAR value). This is calculated by using the nominal coupon rate yield (ex: 6% yields $60) and dividing that by the current PAR market value. (ex: 98 PAR is valued at $980) giving you a current yield (CY) of 6.1% (60/980 = 0.061) Reminder to move the decimal down twice!

Question 29

Yield to maturity (YTM) / Accretion & Amortization

Answer 29

✅ Refers to the yield (interest paid) if the bond is held until date of maturity. Accretion - used when bond is purchased below PAR value. Amortization - used when a bond is purchased above PAR value

Question 30

Yield to call (YTC)

Answer 30

✅ Refers to the yield gained when a bond is surrendered (called by the company) prior to the date of maturity.

Question 31

Yield to worst (YTW)

Answer 31

✅ Calculated by finding YTM (yield if held to maturity) and all YTC (all dates a bond can be called) and picking the worst (lowest) yield.

Question 32

Total return

Answer 32

✅ Refers to the total return on an investment over a period of time. Provides you with a percentage of total gain or loss of an investment. To determine follow these steps (not on SIE) Determine initial cost Calculate dividends/interest received over the time of the investment. Add the interest or dividends to the selling price Divide that number by the initial cost and subtract 1.

Question 33

What is Basis point (bps)?

Answer 33

✅ A unit of measurement equal to 1/100th of 1% (or 0.01%), used to express changes in interest rates, yields, and other financial percentages like expense ratios.

Question 34

What does the term Accrued interest refer to?

Answer 34

✅ Refers to the interest earned that has not been paid since the last payment was made. ✅ Corporate/municipal accrued interest is calculated with 30-month days and 360-year days. ✅ US government bonds and notes are calculated with actual days in the month and 365-day years.

Question 35

How often is interest paid out?

Answer 35

✅ Interest is paid out twice a year!

Question 36

What is the significance of an issuers credit rating?

Answer 36

✅ The likelihood an issuer will default on a bond. (Not pay you interest on scheduled days or PAR when it matures.) ✅ Bond ratings can have plus or minus (S&P) or numbers 1,2,3 (Moodys) to add another layer of rating.

Question 37

What are the two main bond credit rating companies?

Answer 37

✅Moodys and Standard & Poors (S&P)

Question 38

What does the term 'junk bond' refer to?

Answer 38

✅ A risky bond with a higher coupon rate to compensate due to the issuer being rated low; BB (S&P) or Ba (Moodys). The rating is an indicator of how likely an issuer is may default.

Question 39

Bond Type - Callable bond

Answer 39

✅ A bond that can be bought back (called) by the issuer at the price stated within indenture document. ✅ Call provision within indenture document lists call date (first date a bond can be called) and call price (price investor receives). ✅ Considered riskier since investor does not control how long they can hold the bond ✅ Most are issued with call protection - a premium that will be paid if the issuer calls the bond back within specified number of years. ✅ Some callable bonds have ‘call premiums’ that are paid above PAR in the event an issuer calls a bond back within year(s) of a call protection expiring.

Question 40

Bond Type - Put bonds

Answer 40

✅A bond that can be redeemed by the investor at any time stated in the indenture for the price specified. Considered less risky and rarely issued.

Question 41

Why might an issuer choose to call a bond, and an investor choose to put a bond?

Answer 41

An issuer calls a bond when interest rates are low, so they can refinance at a lower cost. An investor puts a bond when interest rates are high, so they can reinvest at higher yields.

Question 42

Bond Type - Convertible bonds

Answer 42

Bonds that can be converted for common stock. - Attractive to investors that are interested in both the common stock and the bonds. - Conversion ratio is determined by dividing PAR value by the conversion price. - Parity refers to when bonds and the equal amount of common stock is trading for the same price.

Question 43

How do you calculate the parity price of a convertible bond?

Answer 43

Multiply the number of common shares the bond converts into by the current market price of the stock. Example: If a bond converts into 25 shares and the stock is trading at $36, Parity Price = 25 × $36 = $900

Question 44

What are the main risks associated with U.S. Government-issued securities (like Treasury bills, notes, and bonds)?

Answer 44

✅ Very low credit/default risk (backed by the U.S. government) ⚠️ Interest rate risk (prices fall when rates rise) ⚠️ Inflation risk (purchasing power may decrease over time) ⚠️ Reinvestment risk (if rates are lower when coupon payments are reinvested)

Question 45

What are the risks of municipal bonds (issued by states, cities, or local governments)?

Answer 45

⚠️ Credit/default risk (not guaranteed—varies by municipality’s financial health) ⚠️ Interest rate risk (prices fall when rates rise) ⚠️ Liquidity risk (may be harder to sell quickly at fair value) ⚠️ Reinvestment risk (if rates are lower when coupon payments are reinvested) ✅ Often exempt from federal income tax, which can offset some risk

Question 46

What risks are associated with corporate bonds?

Answer 46

⚠️ Credit/default risk (company could go bankrupt) ⚠️ Interest rate risk (prices fall when rates rise) ⚠️ Liquidity risk (especially for lower-rated or smaller issuers) ⚠️ Reinvestment risk (if rates are lower when coupon payments are reinvested) ⚠️ Call risk (company may redeem bond early if rates fall)

Question 47

US government securities maturity dates and characteristics - US Treasury Bill (T-Bill)

Answer 47

✅Mature - 4, 8, 13, 17, 26, and 54 weeks (short term) ✅Characteristics - Issued at a discount and mature at PAR, the difference in the price and PAR value is considered the interest (even if none is paid). Minimum is $100.

Question 48

US government securities maturity dates and characteristics - US Treasure note (T-note)

Answer 48

✅ Mature - 2, 3, 5, 7, and 10 years. ✅ Characteristics - Pay interest every 6 months, minimum purchase is $100.

Question 49

US government securities maturity dates and characteristics - Treasury bonds (T-Bonds)

Answer 49

✅ Mature - 20 or 30 years (long term debt securities) ✅ Characteristics - pay interest every 6 months, minimum is $100.

Question 50

US government securities maturity dates and characteristics - T-STRIPS (separate trading of registered interest and principal of securities)

Answer 50

✅ Mature - 6 months to 30 years ✅ Characteristics - considered to be zero coupon securities issued at a discount and mature at PAR. Don’t receive interest payments. Minimum face value must be $100

Question 51

US government securities maturity dates and characteristics - TIPS (Treasury protection inflation securities)

Answer 51

✅ Mature - 5, 10, and 30 years ✅ Characteristics - pay interest every 6 months, PAR value and interest adjust based on inflation and deflation. Minimum is $100.

Question 52

How are U.S. Government securities and municipal bonds typically taxed?

Answer 52

✅ U.S. Government securities (e.g., Treasuries): Exempt from state and local taxes, but taxable at the federal level 🏙️ Municipal bonds: Exempt from federal taxes, and may also be exempt from state/local taxes if issued in your state

Question 53

What is the correlation between the issuers credit rating and the coupon rate?

Answer 53

✅ The higher the rating - the safer and less interest ✅ The lower the rating - the riskier and more interest

Question 54

What is the significance of accrued interest when selling a bond?

Answer 54

✅ If a bond is being sold, the seller is entitled to the accrued interest for the time they’ve held it but not been paid.

Question 55

What is the timeline for accrued interest?

Answer 55

✅ Accrued interest is calculated from the trade date, up to, but not including the settlement date.

Question 56

How is yield to maturity quoted?

Answer 56

✅ Yield to maturity is quoted in basis points

Question 57

How are Treasury Notes Quoted?

Answer 57

✅ Quoted in whole bond points or 1/32 or 0.03125

Question 58

How are Treasury Bonds Quoted?

Answer 58

✅ Quoted in whole bond points or 1/32 or 0.03125

Question 59

How are Corporate Bonds Quoted?

Answer 59

✅ Corporate bonds are quoted at whole bond points or 0.125 or 1/8th of a percent

Question 60

What are the two ways bonds can be quoted?

Answer 60

✅ - Priced as a yield ✅ - Priced as a percentage of PAR

Question 61

What is a bond point equal to?

Answer 61

✅ Represents one hundredth, or one percent of a bonds par value or face value. It represents 1% of the PAR value of the bond.

Question 62

Define Current Yield

Answer 62

✅ Current yield is defined as the rate an investor earns if he/she purchases and holds the bond for a year

Question 63

Define Bond Priced as a yield

Answer 63

✅ - A bond priced (quoted) as a yield is expressed in basis points (BPS), the yield refers to the return an investor will receive on a bond. Usually, Municipality issued debt securities

Question 64

Define Bond Priced as a percentage of PAR

Answer 64

✅ A bond priced (quoted) as a percentage is expressed in bond points. Usually Corporate and US Government securities