Lecture 8 Flashcards
bond = ?
an agreement between lenders and the borrowing organisation (typically a firm or government body)
are lenders also bondholders?
yes
do lenders/bondholders have advantages over shareholders?
yes
why do bondholders have advantages over shareholders?
shareholders will lose the value of their investment if the firm went bust
however bondholders are obliged to be paid regardless of bankruptcy
do bondholders have voting rights?
no
par value/face value = ?
the principal amount that the issuer is obligated to pay at maturity date
coupon rate = ?
annual rate on a bond
coupon payment = ?
interest payment on a bond
annual coupon = ?
coupon rate x par value
maturity = ?
the specified date on which the principal amount of a bond is paid
trust indenture = ?
an extensive document between a bond issuer and a trustee
details the provisions and covenants of the loan arrangement
how do bonds work?
when a company wants to raise funds, they allow various people to give the firm loans in the form of bonds
the investors give loans to the firms
what are various provisions of a bond loan arrangement?
par value
maturity date
coupon rate
trustee = ?
represents the bondholders to ensure the bond issuer respects the indenture’s provisions
covenants = ?
outlines that impose restrictions or extra duties on the firm
promises
what do bond ratings do?
they assess the ability of the issuer to make timely payments of interest and principal
they show the risk/quality associated with the bond
investment grade bonds = ?
bonds with Baa3, BBB- or better
they have lower risk
junk bonds = ?
rated Ba1, BB+ or lower
they have higher risk
what does moody’s bond ratings look like?
Aaa, Aa1, Aa2….Baa1, Baa2….Caa, a, C
what does S&P and Fitch’s bond ratings look like?
AAA, AA+, AA….BBB+, BBB….CCC, CC, C, D
“coupon ticker: ford motor credit (F)” = ?
the firm’s ticker symbol ‘F’ symbolises ford motor credit
“coupon: 7.000” = ?
coupon rate is 7%
“maturity: 2027” = ?
bond matures in 2027
“last price: 117.26” = ?
bond’s closing price as a percentage of par value is 117.26%
e.g, par value is £1000, 117.26% * £1000 = £1172.60 closing price
“last yield: 3.76” = ?
an estimate of the investor’s return on the bond if it was purchased today and held to maturity
last yield was 3.76%
“spread: 236” = ?
the difference between the yield to maturity on the bond and a similar US treasury bond is 236 basis points (2.36%)
“UST: 5” = ?
the maturity length of a similar US treasury bond is 5 years
“est. $ vol (000s): 230,068”
expected trading volume of the bond is $230,068,000
what information is quoted for corporate bonds?
company ticker symbol
coupon rate
maturity date
last price
last yield
spread
UST
est. vol
what information is quoted on treasury bonds?
coupon rate
maturity mo/yr
bid price
asked price
% chg.
asked yield
“rate: 4.000” = ?
coupon rate for the bond is 4% of par value
“maturity mo/yr: feb 27” = ?
bond matures in February 2027
“bid: 100:27” = ?
the price to buy the bonds is 100 27/32% of of par
e.g., par value = £1000, bid price is £1008.44
27/32% + 100% * £1000 = £1008.44
“asked: 100:28” = ?
the price to sell the bonds is 100 28/32% of par
e.g., par value = £1000, asked price is £1008.75
28/32% + 100% * £1000 = £1008.75
bid-ask spread = ?
represents dealer profit, the difference between the bid and ask price
spreads often indicate…?
how liquid a security is
the narrower the bid-ask spread, the greater the liquidity (& usually greater trading volume)
“chg.: -1” = ?
change in price was -1/32 of a percentage point
“asked yld: 1.95” = ?
yield to maturity on asked price is 1.95%
price of an asset = ?
present value of future expected cash flows
cf/1+r + cf/1+r to the power of 2 + cf/1+r to the power of 3 + cf/1+r to the power of 4 etc…
the value of a bond with annual coupon payments = ?
bond value = present value of the coupons + present value of the par value
coupon payment cf/(1+r) to the power of 0 + coupon payment cf/(1+r) to the power of 1 + face value + coupon/(1+r) to the power of 2
price = ?
the bond’s value in period zero
CF = ?
the coupon payment
par value = ?
the bond’s principal amount
r = ?
the rate of return required by investors on this quality risk-class of bonds
interest rate
intrinsic value = ?
the maximum price to pay for an asset
the best estimate of the economic value of an asset based on a forecast of future cash flows and an estimate of the appropriate discount rate
what is the equation if coupons are paid semi-annually?
r is the semi-annual discount/compound rate
r/2
YTM (using APR) = r x 2; YTM/2 = r
n = # of years to maturity x 2
suppose a semi-coupon bond has a $1,000 par value, coupon rate 8%
paid once per year and 10 years until maturity. The YTM is 10%, What is the bond
price?
r = YTM (10%) / 2 = 5%
n = 10 x 2 = 20
pv coupons = $1000 x 1.08 = $80 / 2 = $40 … $40 x ((1-1/1.05 to the power of 20) / 0.05) = $498.49
pv face value = $1000/1.05 to the power of 20 = $376.89
total bond value = 498.49 + 376.89 = $875.38
bond value < face value = ?
sell at discount
bond value > face value = ?
sell at premium
suppose a semi-coupon bond has a $1,000 par value, coupon rate 8%
paid once per year and 10 years until maturity. The YTM is 6%, What is the bond
price?
r = YTM/2 = 3
n = 10 x 2 = 20
pv coupons = 1000 x 1.08 = 80/2 = 40; 40 x ((1-1/1.03 to the power of 20)/0.03) = 595.1
pv face value = 1000/1.03 to the power of 20 = 553.68
total bond value = 553.68 + 595.1 = 1148.78
suppose a semi-coupon bond has a $1,000 par value, coupon rate 8%
paid once per year and 10 years until maturity. The YTM is 8%, What is the bond
price?
r = YTM/2 = 4%
n = 10 x 2 = 20
pv coupons = 1000 x 1.08 = 80/2 = 40; 40 x ((1-1/1.04 to the power of 20)/0.04) = 543.61
pv face value = 1000 / 1.04 to the power of 20 = 456.39
total bond value = 456.39 + 543.61 = 1000
interest rate risk = ?
fluctuating interest rates lead to varying asset prices
bond value = face value = ?
sell at face value
rising interest rates have what impact on bond prices?
rising interest rates lead to falling bond prices
falling interest rates have what impact on bond prices?
falling interest rates lead to rising bond prices
what is the relationship between interest rates and bond prices described as?
the seesaw effect
when everything else is equal, the longer the time to maturity…
has what impact on interest rate risk?
the longer the time to maturity, the higher the interest rate risk
when everything else is equal, the lower the coupon rate…
has what impact on interest rate risk?
the lower the coupon rate, the greater the interest rate risk
what are the 3 types of US government bonds?
treasury bill
treasury note
treasury bond
treasury bill = ?
debt instrument issued by the us government and has less than 1 year maturity
treasury note = ?
debt instrument issued by the US government and has between 1-10 year maturity
treasury bond = ?
debt instrument issued by the US government and has more than 10 year maturity
what impact does interest rate risk have on investors’ demands?
investors will demand a larger risk premium for bonds whose price is especially sensitive to interest rate changes (higher interest rate risk)
horizon risk premium = ?
additional expected return to compensate for risk associated with investing in a longer-term bond with the same credit risk as a shorter-term bond
what’s the difference in YTM between long term bonds with low coupon rates and short-term bonds with high coupon rates?
expect higher yields to maturity (YTM) for long term bonds with low coupon rates than for short-term bonds with high coupon rates
