Lecture 11

Question 1

Debt finance advantages (3)

Answer 1

• Lower cost than equity finance (lower transaction costs/ rate of return)
• Debt holders don’t generally have votes
• Interest is tax deductible

Question 2

Debt finance disadvantage (3)

Answer 2

• Committed to repayments and interest can be risky
• Use of secured assets for borrowing can be onerous constraint on management
• Covenants may restrict managerial action

Question 3

Bonds =

Answer 3

Debt

Question 4

Indenture =

Answer 4

Contract between issuer and bondholder. Includes coupon rate, maturity date and par value.

Question 5

Face/ par value =

Answer 5

Principle repaid at maturity

Question 6

Coupon rate =

Answer 6

Interest repayment, usually paid semi-annually

Question 7

Zero-coupon bonds =

Answer 7

No coupon payment, sold at large discount to par value

Question 8

Floating/ variable bond =

Answer 8

Pay variable coupon rate depending on short term interest/ inflation rates

Question 9

Bonds are issued by

Answer 9

Governments (risk free) / companies (more risky)

Question 10

Bond Interest rate =

Answer 10

Government interest rate for same maturity + Default risk premium

Question 11

Risk premium of bond depends on

Answer 11

Company’s credit rating

Question 12

US Treasury bonds (2)

Answer 12

• Purchased directly from the treasury

- Common denomination = $1000

Question 13

Quoted price (flat price) doesn’t include

Answer 13

Interest that accrues between coupon payment dates

Question 14

Invoice price =

Answer 14

Flat price + accrued interest

Question 15

If a bond is purchased between coupon payment dates

Answer 15

Buyer must pay seller for accrued interest

Question 16

Accrued interest calculation =

Answer 16

(Annual coupon payment / 2) x (Days since last coupon payment / Days separating coupon payments)

Question 17

Corporate bond types (4)

Answer 17

• Callable
• Convertible
• Puttable
• Floating rate

Question 18

Callable bonds =

Answer 18

Can be repurchased before maturity date

Question 19

Convertible bonds =

Answer 19

Can be exchanged for shares in a firm’s common stock

Question 20

Puttable bonds =

Answer 20

Gives bondholder the option to retire/ extend bond

Question 21

Floating rate bond =

Answer 21

Adjustable coupon rate

Question 22

Preferred stock > equity and fixed income characteristics (4)

Answer 22

• Dividends are paid in perpetuity
• Non-payment of dividends does not result in bankruptcy
• Preferred dividends are paid before common
• Non tax break (not tax deductible)

Question 23

Foreign bonds =

Answer 23

Issued by borrower from different country to where sold

Question 24

Yankee bonds =

Answer 24

US

Question 25

Samurai bonds =

Answer 25

Japan

Question 26

Bulldog bonds =

Answer 26

UK

Question 27

Eurobonds =

Answer 27

Bonds which are denominated in one currency but sold in other national markets

Question 28

Eurodollar bonds =

Answer 28

Dollar-denominated bonds sold outside the US

Question 29

Inverse floaters =

Answer 29

Coupon rate falls when general interest rates rise

Question 30

Double effect for inverse floaters in

Answer 30

Present value of money and the level of cash flows

Question 31

Asset-backed bonds =

Answer 31

Coupon rate is tied to assets eg Walt Disney - performance of films

Question 32

Catastrophe bonds =

Answer 32

Transfer ‘catastrophe risk’ from firm to capital markets, increased coupon rates due to increased risk

Question 33

Indexed bonds =

Answer 33

Make payments tied to the general price index/ commodity

Question 34

Price and yields have

Answer 34

Inverse relationship

Question 35

Bond price curve is

Answer 35

Convex

Question 36

Longer the maturity

Answer 36

More sensitive bond’s price is to changes in market interest rates

Question 37

Yield to maturity =

Answer 37

Interest rate that makes the present value of a bond’s payment = price

Question 38

Yield to maturity commonly interpreted as

Answer 38

The interest rate that measures the average rate of return earned on a bond if bought now and held until maturity (bond’s internal rate of return).

Question 39

Current yield =

Answer 39

Annual coupon payment / Bond Price

Question 40

For bonds selling at a premium

Answer 40

Coupon rate > Current yield > YTM