Unit 2 3 Debt Securities (Bonds)

Question 1

As regards Bonds, who is the debtor and who is the creditor?

Answer 1

People who own bonds, (people who own debt) have loaned money to the bond issuer. So, the bond issuer the company or the municipal government or the federal government, whoever issues the bond, are borrowing the money.
So, the issuer is the debtor and the investor is the creditor.

Question 2

Every bond that is issued has what (regarding time)?

Answer 2

A Maturity

Question 3

What is the maturity of a bond?

Answer 3

When the bond reaches the end of it’s lifetime.

Question 4

What is the maturity value of a bond

Answer 4

maturity value is also known as par
01:01
value is also known as the principal
01:04
amount is also known as the face amount

Question 5

Unless you are told otherwise, what is the maturity value on a bond?

Answer 5

$1,000 (unless you are told otherwise.

Question 6

What is the par value on a bond?

Answer 6

$1,000

Question 7

If a bond issuer issued a 15 year bond or a 20 year bond, or a 30 year bond, what do those dates represent?

Answer 7

Maturity periods.

Question 8

What happens at the end of a Maturity period?

Answer 8

At the end of that period, the bond would mature, would be redeemed, and the bond would no longer exist.

Question 9

What are the 3 different types of maturities with Bonds?

Answer 9

1- Term bonds
2- Serial bonds
3- Balloon bond

Question 10

What is a Term bond?

Answer 10

The entire Principle is called at one time.

Question 11

How do Term Bonds work?

Answer 11

We might have a corporation who issues 10 million dollars in bonds, and the entire bond issue will mature in 30 years. That would be a term bond. The entire bond issue would mature at one time.

Question 12

How does a Serial Bond work?

Answer 12

The issuer could issue a serial bond. A
portion of the bond would mature or be repaid over several years. Ex: We have an issuer, a corporation that sells ten million dollars worth of bonds. Three million dollars of those bonds mature in 15 years, another three million matures in twenty-five years, and the balance would mature at the end of 30 years. We have a serial of maturity dates. Different maturity dates.

Question 13

Why would an issuer issue serial bonds?

Answer 13

To reduce their interest costs. the bonds that have the shortest maturity period would have a lower interest rate paid bonds that have the longer maturity would have a higher interest rate paid.

Question 14

How does a Baloon bond operate?

Answer 14

A bond could be issued with a balloon maturity. The majority of the principal would mature at one time. A big balloon payment. The principal repaid over time, with a
majority paid at the end of the balloon period.

Question 15

What is an example of a Balloon Bond?

Answer 15

Maybe we issue 10 million dollars worth of bonds. 2 million dollars of the bonds come due in 15 years. The balance, the 8 million dollar balance comes due in 25 years. So the majority comes due at one time in the
form of a balloon payment.

Question 16

When an investor buys a bond, what’s their objective? What is an investor looking to do?

Answer 16

They buy bonds for the interest income. Bonds will pay an interest rate.

Question 17

What are the different names used for the interest rate on a bond?

Answer 17

This interest rate is also known as the stated rate.
It’s also known as the nominal yield.
It’s also known as the coupon rate.

Question 18

How is the rate of interest calculated on a bond?

Answer 18

The interest is calculated annually as a percent of par. Interest is paid semi-annually.
Ex: Let’s say we have a 7% bond. This bond pays 7% of
$1,000 par value. $1,000 yearly so 7% of a thousand. This bond would pay $70 in annual interest,

7% divided by 1,000 = 0.07
0.07 x 100 = 7(%)
1,000 x 7% = $70

Question 19

How often is interest paid on bonds?

Answer 19

interest is paid semi-annually. Divide $70 (from the example) by two and the investor would receive $35 in
bond interest every six months

Question 20

What do you need to do with bonds as to nomenclature?

Answer 20

now folks please be sure that you know all the different terms that stand for the maturity value. All the different terms that stand for the coupon rate. Maturity value is also known as the par value - also known as the
principal amount also known as the face amount. The coupon rate is also known as the interest rate also known as the stated rate also known as nominal yield
these terms will be used interchangeably on the exam so know the different terms.

Question 21

How does the inverse interest rate work with bonds?

Answer 21

Bond prices have an inverse relationship to interest rates. This simply means, if interest rates were to go up, the price of existing bonds would go down. If interest rates go down, the price of existing bonds would go up.

Question 22

How do you calculate the amount a bond is worth? Say, a 94 1/4 priced bond?

Answer 22

Let’s say we have a bond priced at 94 and one quarter points. We want to turn this into a dollar amount.
Take the one quarter, and would turn it into a decimal
1/4 is 0.25 so the bond is priced at 94 point two five points. Each point is worth $10. Multiply that times 10 and I find that a bond priced at ninety four and a quarter points would be priced at nine hundred and forty two dollars and fifty cents. That bond is priced below par ($1,000?) which would be a discount bond.

Question 23

What makes a bond a discount bond?

Answer 23

It’s priced below par or $1,000

Question 24

How do you calculate the price of this bond example?

(Bond priced at 102 1/2)?

Answer 24

If a bond instead is priced at 102 and a half points, turn
that into a dollar amount. First, turn the fraction to a decimal 1.e., one divided by two is 0.5 so 102.5 each points worth $10 multiplied times 10025 would be the dollar price of that bond now that bond is priced above
par that bond is priced at a premium. Interest rates went down since that bond was issued therefore the price went up. It’s now a premium bond.

Question 25

How do you calculate the price of a bond at 100 points?

Answer 25

If I have a bond price that 100 points each point is worth $10 I multiply times 10 I find the price of that bond is $1,000 that bond is priced at par.

Question 26

What are the 4 Yields as regards bonds?

Answer 26

There’s the nominal yield NY,
the current yield CY,
the yield to maturity YTM which is also known as the basis and
the yield to call YTC.
I don’t expect them to ask you to calculate yields other than maybe the current yield. To calculate the current yield, I simply take my annual income divided by the current market value is my current yield.
I don’t expect them to ask you to calculate any of the other three yields but they will expect you to know the relationship of yields to one another.

Question 27

What is the coupon yield of a bond? How is it calculated?

Answer 27

Add up 1 year of the amount of the coupons and divide the sum into the par value.
Ex: $50 (coupon rate) / by 1,000 = 5%
or ($50/1,000 = 0.05 x 100% = 5%
This is called Coupon Yield.

Question 28

How do you determine (calculate) the Current Yield of a bond?

Answer 28

Coupon amount divided by the price of the bond = current yield.
Ex: Coupon $50 Price $1200
50 / 1200 = 4.16666 (rounded up) 4.2%

Question 29

How do you calculate Yield to Maturity, the most important consideration in valuing a bond?

Answer 29

Term of (15 yrs.) is the same in all 3 examples. Coupon rate is the same in a 3 examples. The only difference is the price when it was purchased. 
1- Paid a premium (more than face value) $1200 for the bond. Coupon payment he will receive = $1,098. He is reinvesting interest made (twice per yr) at 5% also. He paid $200 more than what he will get back when bond matures ($1,000). So, $1098 - $200 = $898  At maturity the yield (Yield to Maturity) is 3.3%

Question 30

How do you calculate Yield to Maturity YTM on a 15 yr term, 5% yield with a $50 annual coupon that one paid $1000 for?

Answer 30

“In short, the values are as advertise i.e., the yield is 5% if you paid $1000 for a 15yr term (or 30 for that matter) with a $50 annual coupon. (See Warren Buffet on Bonds OneNote video)

Question 31

How do you calculate YTM on a 15 yr $50 coupon bond you paid $800 for (with 5% advertised yield)?

Answer 31

One has to account for the $200 “discount” the bond was purchased for (FV = $1000 you paid $800. The gain of $200 (paid at maturity) is added to the coupon ofit $1098 giving you $1298 the YTM is actually 7.2%
(See Warren Buffet on Bonds OneNote video)