Module 2 Flashcards
Bond
A long term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the holders of the bond.
Treasury bonds
bonds issued by the federal government, sometimes referred to as government bonds
Corporate bonds
bonds issued by corporations
Municipal bonds
bonds issued by state and local government
Foreign bonds
bonds issued by foreign government or by foreign
corporations
Par value of a bond
face amount of the bond, which is paid at maturity
Coupon interest rate
stated interest rate (generally fixed) paid by the issuer. Multiply by par value to get dollar payment of interest
Maturity date
years until the bond must be repaid
Issue date
when the bond was issued
Yield to maturity
rate of return earned on a bond yield held until maturity
(also called the “promised yield”)
Call provisions on bonds
- Allows issuer to refund the bond issue if rates decline (helps the issuer, but hurts the investor)
- Bond investors require higher yields on callable bonds.
- In many cases, callable bonds include a deferred call provision.
Convertible bond
may be exchanged for common stock of the firm, at the
holder’s option
Warrant
long term option to buy a stated number of shares of common
stock at a specified price.
Putable bond
allows holder to sell the bond back to the company prior to
maturity.
Income bond
pays interest only when interest is earned by the firm.
Indexed bond
interest rate paid is based on the rate of inflation.
The value of any financial assets a stock, a bond, a lease, or even a physical asset such as an apartment building or a piece of machinery is .
the present value of the cash flows the asset is expected to produce.
bond sells at a premium
the coupon rate > the yield to maturity
bond sells at a discount when
the coupon rate < the yield to maturity
Bonds with semiannual coupons
Bond Yields
Yield to Maturity
Bond Yields can also be viewed as…
Can also be viewed as the bond’s promised rate of return , which is the return that investors will receive if all of the promised payments are made.
YTM equals the expected rate of return only when
(1) the probability of default is zero
(2) the bond cannot be called
T or F
If there is some default risk or the bond may be called, there is some
chance that the promised payments to maturity will not be received.
True
Yield to call
- If you purchase a bond that is callable and the company calls it, you do not have the option of holding it to maturity.
- Therefore, the yield to maturity would not be earned.
- For example, if a company’s 10% coupon bonds were callable and if interest rates fell from 10% to 5%, the company could call in the 10% bonds, replace them with 5% bonds, and save $100 –$50 = $50 interest per bond per year; beneficial to the company, but not to its bondholders.
YTC is the …
Changes in Bond Value over Time
What would happen to the value of these three bonds if the required rate of
return remained at 10%
Changes in Bond Value over Time
The two key factors that impact a bond’s riskiness
- Price risk
- Reinvestment risk
Price risk
Reinvestment risk
Default Risk
Assessing a Bond’s Riskiness
