Investment Vehicles: Debt Securities

Question 1

Describe the following for Corporate bonds:
1. issuer
2. taxation on interest
3. risk
4. coupons
5. yield
6. SEC registration
7. quotation type and example

Answer 1

Corporate bonds:
1. issuer: publicly traded corporation
2. taxation on interest: fully taxable at Fed, state, & local level
3. risk: riskiest
4. coupons: highest
5. yield: highest
6. SEC registration: subject to SEC registration
7. quotation type and example: $ in 1/8ths; i.e. 96 3/8

Question 2

Describe the following for Government bonds:
1. issuer
2. taxation on interest
3. risk
4. coupons
5. yield
6. SEC registration
7. quotation type and example

Answer 2

Government bonds:
1. issuer: Fed Gov
2. taxation on interest: Fully taxable at Fed level only (exempt state & local)
3. risk: Safest
4. coupons: mid-range
5. yield: lowest
6. SEC registration: exempt from SEC registration
7. quotation type and example: 1/32; 96.06 = 96 6/32 = $96*10 + 6/32 * 10

Question 3

Describe the following for Municipal bonds:
1. issuer
2. taxation on interest
3. risk
4. coupons
5. yield
6. SEC registration
7. quotation type and example

Answer 3

Municipal bonds:
1. issuer: state & local gov
2. taxation on interest: exempt Fed & usually exempt local & state
3. risk: middle
4. coupons: lowest
5. yield: mid-range
6. SEC registration: exempt from SEC registration
7. quotation type and example: 1/8th or yield to maturity; @96 3/8 or 4.75%

Question 4

Define corporate funded debt

Answer 4

Corporate funded debt is the debt of a corporation that is long-term with 1 or more years to maturity

Question 5

Define debenture

Answer 5

Debenture - an instrument of debt backed by the good faith and credit of the issuing corporation. it is an unsecured debt meaning the bond is not backed by any collateral

Question 6

Define subordinated debenture

Answer 6

Subordinated debenture would be a debenture bond which is lesser in claim to other debenture bonds, thus would be paid second to any other outstanding debentures

Question 7

Define secured debt

Answer 7

Secured debt is debt that is backed by the pledge of assets or other collateral such as mortgage bonds and equipment trust certificates

Question 8

Describe zero-coupon bonds

Answer 8

Zero-coupon bonds:
- sold at deep discounts and pay all interest and principal in one payment at maturity
- interest is the difference between the purchase price and the value of the bond at maturity
- the bond’s pricing formula is calculated similarly to the pricing formula on a coupon bond
- purchased by investors seeking accumulation of capital (do not pay semi-annual interest and are most volatile type of bond issued)

Question 9

Formula for Common Shares Received

Answer 9

par value
__________________ = common shares received
conversion price

Question 10

Describe junk bonds

Answer 10

Junk bonds are bonds issued by companies without long track records of sales and earning or which have questionable credit strength.
- also called high yield bonds
- usually more volatile than investment grade bonds but pay higher yields than investment grade bonds
- sometimes used to finance takeovers
- bonds rated lower than BBB (investment grade rating) are junk bonds

Question 11

Describe callable bonds

Answer 11

Bonds can be called (redeemed) at the option of the issuer at a pre-established premium price, after a specified date
- call features are advantageous to the issuer not investor
- the “call provision” will specify the callable date and price
- a call price can place a ceiling on the appreciation possibilities since a company might call in a a high coupon bond if interest rates decline (rates go down, price goes up)

Question 12

Why is a convertible bond advantageous to the bondholder?

Answer 12

A bondholder has the advantage of being a creditor, yet has the possibility of receiving capital gains if the common sells at a premium over parity

Question 13

Describe convertible bonds

Answer 13

Convertible bonds:
1. convert to shares of common stock at the option of the bondholder
2. the coupon rate of a convertible bond is normally lower than a non-convertible bond of the same quality
3. convertible securities typically have more volatile market value than those of non-convertible (b/c tied closely to common shares mv)

Question 14

What are the types of corporate bonds?

Answer 14

1. debenture
2. subordinated debenture
3. secured debt
4. zero-coupon bond
5. junk bonds
6. callable bonds
7. convertible bonds