Topic 4- Bonds Flashcards
What is a bond?
A financial claim with a promised Cf at t
What makes a bond better than a loan?
can add more features not in a loan
Issuing a bond creates ___
a bond indenture (contract) which legally protects investor (bond holder)
The two levels of security of a bond are?
- collateralised (secured to an asset)
- debentures (insecure (secure in NZ/AUS))
What is the seniority ranking of bonds?
Senior (paid first)
Junior
Subordinate
4 bond issuers
- government
- local govs
- companies
- celebrities
Formula for coupon amount
C= fV x CR
A zero coupon bond
pays no regular interest
Bond Price formulae
C/YTM x (1- (1/(1+YTM)^(t))) + fv/(1=YTMM^(t)
- adjust t and Ytm accordingly
YTM = CR
Par bond
YTM < CR
premium bond
YTM > Cr
discount bond
Bond price movements are ____ to int rate movement
inversely proportional (int rate increase, p decreases)
When a bond is first issues the what are equal?
CR= IR BP= fV
The downside of the bond market
the lack of transparency and its difficult to get up to date prices
As time goes on in the bond market price changes in response to___ and __
calendar turn
market shifts
The life of a bond decreases as t goes on and maturity approaches
calendar turn
the YTM changes in response to the news information
market shift
Bond risks
interest rate risks
inflation risk
default risk
The relationship between maturity, CR and sensitivity/risk
a bond with a HIGHER maturity or LOW coupon rate is more sensitive to IRR
IRR
potential changes in bond price as IR fluctuates
Inflation risk
an increased rate of inflation decreases the real value of interest you earn
default risk
the entity promising payments but unable to deliver
capacity and volatility of CF commitments of a firm with_____
a higher predictable CF and low commitments to CF has a low default risk
Inflation
rising prices decreasing value
inflation 2 formulas
r real approx = r nominal - 1
r real = (1 + r nominal/1+ inflation) -1
What is the treasury yield?
The benchmark for IR for expected inflation
4 Corporate bond yields
default risk premium
inflation risk premium
time preference/real rate
Interest rate risk (term) premium
What is the default risk premium?
Compensation for possibly for default
What is the IRR (term) premium?
compensation for bearing interest rate risk
higher maturity bonds have higher risk so more compensation
What is the Inflation risk premium?
compensation for future inflation
What is the real rate (time preference)?
reward for delayed compensation
The term structure is a curve of ___ by ___
IR by t
An upward sloping term structure is
nominal int rate
A downward sloping term structure is
risk free rate
The term structure is the theoretical ____
rate of return on a default risk investment
Capital structure is the amount of ___ and ____ used by the firm to finance investments in assets
the amount of
The
