Element 5-Bonds Flashcards
What is the definition of a bond and the reason s for issue?
Bond is a debt instrument whereby an investor lends money to an equity (company or government) that borrows the funds for a defined period of time at a fixed interest rate.
The reason for issuing the bonds is for the issuer to raise finance.
What are the bonds issuers?
Companies (corporate bonds) and government (government bonds).
What are the features of bonds?
Repayment date-when the money will be returned.
Frequency of interest payments-% paid as interest and how often.
Tradable-bonds can be sold before they reach their repayment date.
What are the key terms of a “Bond”?
Nominal value of a bond is the amount that is owed by the bond issuer. Also it’s called face value.
Redemption date or maturity date is the repayment date.
Coupon is the interest rate of the nominal value.
Yield is an annual percentage of return.
If the traded price rises above or falls below the nominal value, the yield will be different from the coupon.
Formula: coupon % x nominal value/actual value
What are the advantages and disadvantages of investing in bonds?
Advantages:
Regular income in form of regular fixed coupons.
Fixed maturity date and amount to be paid.
Disadvantages:
There is a possibility that the issuer will fail to pay some or all of the coupons and the redemption amount because it does not have the available funds.
An increased risk of default resulting in a fall in the bonds value.
What are the roles of credit rating agencies?
Credit rating agencies look at bond issuers and assess the credit risk.
There are three dominant credit rating agencies globally - Moody’s, Standard & Poor’s and Fitch Ratings.
AAA/Aaa is rated as “extremely high capacity to meet their financial commitments”.
D is the lowest rating for S & P and Fitch.
There is an important dividing line between bonds that are rated by the agencies. Investment grade and non-investment grade. And it’s drawn just below BBB(Baa).
What are the benefits and risk leverage in a company’s financing structure?
The impact of leverage is that, when a company performs well, it appears that the larger the proportion of the financing that comes from debt, the better. The larger the leverage, the more the gain to the shareholders is magnified.
On the other hand if the company performs badly, then the impact of leverage magnifies the loss to the shareholders rather than the gain.
Financial leverage is the proportion of a debt relative to the equity within a business. The grater the proportion of debt, the more gains in the business are magnified to the shareholders. However, the greater the proportion of debt, the more losses are magnified to the shareholders.
