Fabozzi - 1 Flashcards
What is the par value of a bond?
The amount the issuer agrees to repay the bondholder at maturity.
How are bond prices quoted?
As a percentage of par value, with par value equal to 100.
What is a coupon rate?
The interest rate the issuer agrees to pay each year.
How is the coupon amount calculated?
By multiplying the par value by the coupon rate.
What is a zero-coupon bond?
A bond that does not make periodic coupon payments; the bondholder realizes interest at maturity.
What is a floating-rate security?
A bond whose coupon rate resets periodically based on a formula, usually a reference rate plus a quoted margin.
What is a cap in a floating-rate security?
A maximum coupon rate that can be paid, which is a disadvantage to the bondholder.
What is a floor in a floating-rate security?
A minimum coupon rate that can be paid, which is an advantage to the bondholder.
What is a step-up note?
A bond whose coupon rate increases over time.
What is accrued interest?
The interest that has accrued since the last coupon payment and is owed to the bond seller by the buyer.
What is the difference between full price and clean price?
Full price (dirty price) includes accrued interest, while clean price excludes accrued interest.
What is an amortizing security?
A bond for which there is a schedule for the repayment of principal.
What is a call provision?
An option for the issuer to retire all or part of the bond issue before the stated maturity date.
Who benefits from a call provision?
The issuer benefits, while it is a disadvantage to the bondholder.
What is a deferred call?
A callable bond that cannot be called for a number of years after issuance.
What is a call schedule?
A schedule where the call price depends on when the issuer calls the bond.
What is a make-whole premium provision?
A formula designed to protect the bondholder’s yield when an issuer calls a bond.
What is the difference between regular redemption price and special redemption price?
Regular redemption prices apply to normal calls, while special redemption prices apply to debt redeemed through a sinking fund or other provisions.
What is call protection?
Restrictions that prevent an issuer from calling a bond early.
What is a sinking fund provision?
A requirement for the issuer to retire a specified portion of the bond issue each year.
What is an accelerated sinking fund provision?
An option for the issuer to retire more than the required amount to satisfy the sinking fund requirement.
What is a putable bond?
A bond where the bondholder has the right to sell the bond back to the issuer at a specified price on designated dates.
What is a convertible bond?
A bond that gives the bondholder the right to exchange it for a specified number of shares of common stock.
How do embedded options affect bond valuation?
They make valuation complex by requiring modeling of interest rates and issuer/borrower behavior to project cash flows.
How do institutional investors finance bond purchases?
Typically through repurchase agreements rather than margin buying.
What is a repurchase agreement (repo)?
The sale of a security with a commitment to repurchase it at a specific price on a specific date.
What is the repo rate?
The borrowing rate for a repurchase agreement, generally lower than bank borrowing rates.
What is the difference between a nonamortizing bond and an amortizing bond?
A nonamortizing bond repays principal only at maturity, while an amortizing bond repays principal periodically.
What is the distinction between a noncallable and a nonrefundable bond?
A noncallable bond cannot be called early, while a nonrefundable bond cannot be refunded with lower-cost debt.
What is the difference between call and refunding provisions?
A call provision allows early redemption, while refunding provisions restrict using cheaper debt to replace existing debt.
What is prepayment option?
The right of the borrower to repay principal before the scheduled due dates.
What is margin buying?
Borrowing funds to purchase a security by using the security itself as collateral.
What are affirmative covenants?
Positive obligations that the issuer must adhere to, such as maintaining certain financial ratios.
What are negative covenants?
Restrictions placed on the issuer, such as limitations on additional debt issuance.
What is a currently callable bond?
A bond that has no protection against early call by the issuer.
What are floating-rate securities structured with?
A coupon formula based on a reference rate plus a margin, and may have interest rate caps or floors.
What is the importance of options embedded in a bond issue?
They affect bond pricing, yield, and risk, impacting both issuers and bondholders.
What is a refunding protection?
A restriction on the issuer’s ability to redeem bonds using the proceeds of a lower-cost debt issue.
How does a call provision differ from a sinking fund provision?
A call provision allows for early redemption of the entire issue, while a sinking fund retires a portion of the issue each year.
What is the benefit of a put option to bondholders?
It allows bondholders to sell the bond back to the issuer if interest rates rise or the issuer’s credit deteriorates.
What is a fixed-rate coupon bond?
A bond that pays a fixed interest rate over its entire life.
What is a zero-coupon bond?
A bond that does not make periodic interest payments but is issued at a discount and repaid at face value at maturity.
What is a deferred coupon bond?
A bond that postpones the interest payments until a later date, usually paying higher interest after the deferral period.
What is a floating-rate bond?
A bond with an interest rate that fluctuates based on a reference rate plus a fixed spread.
What are interest rate caps in floating-rate bonds?
A limit on how high the coupon rate can go, which is a disadvantage to the bondholder.
What are interest rate floors in floating-rate bonds?
A limit on how low the coupon rate can go, which is an advantage to the bondholder.
What is accrued interest?
Interest that has been earned but not yet paid since the last coupon payment.
What is the full price (dirty price) of a bond?
The bond price including accrued interest.
What is the clean price of a bond?
The bond price excluding accrued interest.
What is a nonamortizing bond?
A bond that repays the principal in full at maturity without any periodic principal payments.
What is an amortizing bond?
A bond that repays principal periodically over the life of the bond.
What is a call provision?
An option for the issuer to redeem the bond before maturity at a specified price.
What is the difference between call and put options in bonds?
A call option allows the issuer to redeem early, while a put option allows the bondholder to sell the bond back to the issuer.
What is the purpose of a make-whole provision in callable bonds?
It compensates bondholders by ensuring they receive a specified yield if the bond is called early.
What is call protection?
A period during which a callable bond cannot be called by the issuer.
What is a sinking fund provision?
A requirement for the issuer to periodically retire a portion of the bond issue before maturity.
What is a special redemption price?
A price applied when bonds are redeemed through provisions like the sinking fund, which may differ from the regular call price.
What is a nonrefundable bond?
A bond that cannot be redeemed using proceeds from issuing lower-cost debt.
What is a noncallable bond?
A bond that cannot be redeemed early by the issuer under any circumstances.
What is a conversion option in a bond?
A right given to bondholders to convert the bond into a specified number of shares of the issuer’s common stock.
Who benefits from a call option in a bond?
The issuer benefits by redeeming the bond early, typically when interest rates fall.
Who benefits from a put option in a bond?
The bondholder benefits by selling the bond back to the issuer, typically when interest rates rise or the issuer’s credit deteriorates.
What is a sinking fund provision’s advantage for bondholders?
It reduces credit risk by ensuring that part of the bond is repaid periodically.
What is an accelerated sinking fund provision?
It allows the issuer to retire more bonds than required under the sinking fund, often when financially favorable.
What is a margin agreement?
A borrowing arrangement where an investor purchases a security by borrowing money, using the security itself as collateral.
What is a repurchase agreement (repo)?
A short-term borrowing arrangement where a bond is sold with an agreement to buy it back at a future date, typically at a higher price.
What is the repo rate?
The interest rate charged in a repurchase agreement, typically lower than bank borrowing rates.
How is a bond’s coupon formula structured in floating-rate securities?
It is typically based on a reference rate (e.g., LIBOR) plus a fixed margin or spread.
What are the advantages of embedded options for issuers?
They allow flexibility in managing interest rate risks and financing costs, such as calling bonds when rates fall.
What are the advantages of embedded options for bondholders?
They provide the bondholder with options like converting to stock or selling back the bond, offering protection against interest rate or credit risk changes.
What is a make-whole call provision?
A clause that requires the issuer to compensate bondholders for lost interest if a bond is called early, protecting the bondholder’s yield.
What is a deferred coupon bond?
A bond where interest payments are delayed until a specified date, after which they may increase or become regular.
What is a step-up bond?
A bond whose coupon rate increases at specified intervals over time.
What is refunding protection?
A restriction that prevents the issuer from replacing the bond with lower-cost debt until a certain period has passed.
What is the difference between a margin purchase and a repurchase agreement?
A margin purchase uses borrowed funds to buy securities, while a repurchase agreement involves selling a security with a commitment to repurchase it later.
What is the regular redemption price of a bond?
The price at which a bond can be called under normal circumstances, often set above par.
What is a special redemption price of a bond?
A price for redeeming bonds early due to specific provisions, such as a sinking fund, which may be lower than the regular call price.
What is the purpose of call protection in a bond?
To safeguard bondholders from early redemption, ensuring a stable income stream for a defined period.
What is the typical formula for determining the coupon rate in a floating-rate bond?
It is typically the sum of a reference rate (e.g., LIBOR) plus a fixed margin determined at issuance.
What is an affirmative covenant in bond indentures?
A legal obligation requiring the issuer to take specific actions, such as maintaining insurance or specific financial ratios.
What is a negative covenant in bond indentures?
A clause that restricts certain activities of the issuer, such as limiting the amount of additional debt they can incur.
How does an amortizing bond reduce credit risk?
By repaying portions of the principal periodically, reducing the amount owed at maturity.
What is a bond indenture?
A legal contract that outlines the terms and conditions between the bond issuer and bondholders.
What is a fixed-rate coupon bond?
A bond with a constant interest rate paid to bondholders throughout its life.
What is the benefit of a floor in a floating-rate bond?
It ensures that the bondholder receives a minimum interest payment, regardless of how low the reference rate drops.
What is a cap in a floating-rate bond?
A maximum limit on how high the interest rate can rise, protecting the issuer from rising interest costs.
What is a callable bond?
A bond that gives the issuer the right to redeem it before maturity at a predetermined price.
What is a deferred call provision?
A feature that prevents the issuer from calling a bond for a certain number of years after issuance.
What is the call price?
The price at which a bond can be redeemed by the issuer before its maturity, typically higher than the bond’s par value.
What is a put option in a bond?
A feature allowing bondholders to sell the bond back to the issuer at a specified price before maturity.
How does a convertible bond work?
It gives the bondholder the right to convert the bond into a predetermined number of shares of the issuer’s stock.
What is a make-whole premium?
A provision that compensates bondholders for lost interest if a bond is called early, calculated to maintain the bond’s expected yield.
What is a sinking fund?
A fund established by the issuer to retire portions of a bond issue before maturity, reducing the overall debt.
What is the difference between a regular and special redemption price?
The regular redemption price applies to a normal call, while the special redemption price is used for specific provisions like sinking fund redemptions.
What is an amortizing bond?
A bond that repays principal in periodic installments over the life of the bond.
What is the benefit of an amortizing bond for bondholders?
It reduces credit risk by returning part of the principal periodically, decreasing the amount still owed.
What is a currently callable bond?
A bond that has no protection against early redemption and can be called at any time by the issuer.
What is a sinking fund provision’s impact on bondholders?
It decreases default risk by ensuring that the issuer repays portions of the principal over time.
What is a repo transaction?
A short-term agreement where a seller sells a security with the agreement to repurchase it later at a higher price.
How do institutional investors typically finance bond purchases?
They use repurchase agreements (repos) rather than margin borrowing.
What is a repo rate?
The interest rate applied in a repurchase agreement, generally lower than other forms of borrowing.
What is a noncallable bond?
A bond that cannot be redeemed by the issuer before maturity.
What is the advantage of a noncallable bond to bondholders?
It provides bondholders with certainty of interest payments and principal repayment until maturity.
What is the purpose of a prepayment option in bonds?
It allows borrowers to repay part or all of the bond’s principal before the scheduled repayment dates.
How does call protection benefit bondholders?
It ensures that the bond cannot be redeemed early, providing a stable income stream for the bondholder.
What is a step-up coupon bond?
A bond where the coupon rate increases at specified intervals, benefiting investors as interest rates rise.
What is refunding protection?
A feature that prevents the issuer from using cheaper debt to replace existing bonds until a certain period has passed.
What is the clean price of a bond?
The price of a bond excluding any accrued interest.
What is the dirty price of a bond?
The price of a bond including accrued interest, also known as the full price.
What are affirmative covenants?
Legal commitments that require the issuer to meet certain conditions, such as maintaining insurance or financial ratios.
What are negative covenants?
Restrictions in a bond indenture that prevent the issuer from taking certain actions, like issuing more debt or selling assets.
How does an issuer benefit from a call provision?
It allows the issuer to redeem the bond early, often when interest rates have dropped, reducing their borrowing costs.
How does a bondholder benefit from a put option?
It allows the bondholder to sell the bond back to the issuer, usually if interest rates rise or the issuer’s creditworthiness declines.
What is margin buying?
A method where investors borrow money to buy securities, using the purchased security as collateral.
What is the difference between a margin purchase and a repurchase agreement?
A margin purchase involves borrowing funds to buy a security, while a repurchase agreement is a sale of a security with a commitment to buy it back.
What is an embedded option in a bond?
A feature such as a call, put, or conversion option, that gives either the issuer or bondholder additional rights.
How does an accelerated sinking fund provision work?
It allows the issuer to retire more bonds than required under the sinking fund, often used when financially advantageous.
What is the coupon formula in floating-rate securities?
The coupon rate is determined by adding a fixed margin to a reference rate like LIBOR.
What is the difference between a nonrefundable bond and a noncallable bond?
A nonrefundable bond cannot be refinanced with cheaper debt, while a noncallable bond cannot be redeemed early.
How does a make-whole premium protect bondholders?
It compensates bondholders for any lost interest if the issuer calls the bond early, preserving the bondholder’s expected yield.
