Volume 1- Chapter 6 Flashcards
What do fixed-income securities represent?
Debt of the entity that issues them.
What are the two main components of fixed-income securities?
- Promise to repay the maturity value
- Payment of interest at stated intervals or at maturity.
How are interest payments from fixed-income securities taxed?
As ordinary income.
List some types of fixed-income securities.
- Bonds
- Debentures
- Money market instruments
- Mortgages
- Preferred shares.
What is the rationale for issuing fixed-income securities by corporations and governments?
- To finance operations or growth
- To take advantage of financial leverage.
Why do governments borrow money?
When they spend more than they receive in tax revenue.
What is financial leverage?
Using borrowed funds to seek magnified percentage returns on an investment.
What is a bond?
A long-term, fixed-obligation debt security secured by physical assets.
What document outlines the details of a bond issue?
Trust deed.
What happens when a bond issuer defaults?
Bondholders can seize specified physical assets to recover their investment.
Define a debenture.
A type of bond secured by a general claim on residual assets, often referred to as an unsecured bond.
What is par value in relation to bonds?
The principal amount the bond issuer contracts to pay at maturity.
What is the coupon rate of a bond?
The interest rate paid by the bond issuer relative to the bond’s par value.
What is the maturity date of a bond?
The date at which a bond matures and the principal amount is paid back.
What is the term to maturity?
The time that remains before a bond matures.
How is the bond price determined?
Present discounted value of all future payments the bond issuer must pay.
What does it mean if a bond is trading at a premium?
The bond price is above par value.
What is yield to maturity?
The annual return on a bond that is held to maturity.
What are the three categories of bonds based on term to maturity?
- Short-term: more than 1 year but less than 5 years
- Medium-term: 5 to 10 years
- Long-term: greater than 10 years.
What is a money market security?
A special type of short-term fixed-income security generally with a term of one year or less.
What is liquidity in the context of bonds?
The ease with which bonds can be traded.
What are marketable bonds?
Bonds that have a ready market.
Fill in the blank: A bond’s coupon indicates the _______ the bondholder will receive.
income
True or False: Most bonds pay interest annually.
False
What is the typical denomination for bonds issued for a broad retail market?
$1,000 and $10,000.
What is liquidity in the context of bonds?
Liquidity refers to the ease with which bonds can be bought or sold in an active market.
What are negotiable bonds?
Negotiable bonds are bonds that can be transferred and are in good delivery form.
What does ‘good delivery’ refer to?
Good delivery refers to the time when actual paper copies of bonds and fixed-income securities were delivered between investment dealers.
What are marketable bonds?
Marketable bonds have a ready market but are not necessarily liquid.
What is a strip bond?
A strip bond, or zero-coupon bond, is created when a dealer separates the interest coupons from the underlying bond and sells them separately at a discount.
How do strip bonds generate income for investors?
Investors receive no interest payments; instead, they are purchased at a discount and mature at par value.
What is the tax implication of strip bonds?
Tax must be paid annually on the interest income from strip bonds, even though the income is not received until maturity.
What is a callable bond?
A callable bond allows the issuer to pay off the bond before maturity.
What is the call protection period?
The call protection period is the time during which a callable bond cannot be redeemed.
What are extendible bonds?
Extendible bonds are issued with a short maturity but have an option to extend the investment.
What are retractable bonds?
Retractable bonds are issued with a long maturity but allow investors to redeem early at par.
What is a convertible bond?
A convertible bond allows investors to exchange the bond for common shares at a predetermined price.
What is forced conversion?
Forced conversion requires bondholders to convert their bonds into common shares under certain conditions.
What happens when the stock price rises above the conversion price?
The market price of convertible bonds rises accordingly, reflecting their potential to be converted into shares.
What is the significance of a conversion price?
The conversion price is the predetermined price at which a bond can be converted into common shares.
What is a sinking fund?
A sinking fund is a fund established to repay portions of bonds for redemption before maturity.
True or False: Most Government of Canada bonds are callable.
False
Fill in the blank: The income on strip bonds is considered ______ income rather than a capital gain.
interest
What is the typical call price for provincial bonds?
Provincial bonds are usually callable at 100 plus accrued interest.
What happens to the premium payment as the bond approaches maturity?
The premium payment becomes lower as the bond approaches its maturity date.
What is an example of a scheduled redemption for a callable bond?
DEF Corporation’s debentures have a redemption schedule that varies from 103.68 to 100.00.
What is the difference between extendible and retractable bonds?
Extendible bonds can be converted to longer-term debt, while retractable bonds can be redeemed early.
What is a protection against dilution clause in convertible bonds?
This clause adjusts the conversion privilege if the common shares are split.
What is the typical maturity term for extendible bonds?
Typically five years, with an option to extend to a longer term.
What is the typical maturity term for retractable bonds?
At least 10 years, with an option to redeem at par five years earlier.
What is the conversion price of a convertible bond?
The conversion price is calculated as the bond price divided by the number of shares that the bond can be converted into
What are the two ways issuers can repay portions of their bonds before maturity?
- By calling them on a fixed schedule of dates (sinking fund obligation)
- By buying them in the secondary market at or below a specified price (purchase fund)
What are sinking funds?
Sums of money set aside out of earnings each year to provide for the repayment of all or part of a debt issue by maturity
What is a mandatory sinking fund feature?
A feature that requires the issuer to retire a specified amount of debt on a fixed schedule
What is the purpose of a purchase fund?
To retire a specified amount of outstanding bonds through purchases in the market at or below a stipulated price
True or False: Sinking fund provisions are binding on the issuer.
True
What are protective provisions in corporate bonds?
Safeguards in the bond contract to protect the security holder’s position
List some common protective covenants found in Canadian corporate bonds.
- Security clause
- Negative pledge
- Limitation on sale and leaseback transactions
- Sale of assets or merger
- Dividend test
- Debt test
- Additional bond provisions
- Sinking or purchase fund and call provisions
What are Government of Canada securities used for?
To finance deficits, fund programs, and finance infrastructure projects
What types of bonds does the Government of Canada issue?
- Marketable bonds
- Crown corporation debt
What is the characteristic of Treasury bills (T-bills)?
They are short-term government obligations sold at a discount and mature at par value
What distinguishes real return bonds from conventional bonds?
The coupon payments and principal repayment are adjusted for inflation
What are provincial bonds classified as?
Debentures, which are promises to pay without pledged assets as security
What determines the credit quality of provincial bonds?
Factors such as existing debt per capita, federal transfer payments, government stability, and wealth
What are guaranteed bonds?
Bonds that are guaranteed by provincial authorities or commissions
What are the characteristics of provincial savings bonds?
- Only purchasable by residents of the province
- Available only at certain times of the year
- May have specific redemption rules
What type of debenture is commonly used by municipalities?
Instalment debenture (serial bond)
What is the risk comparison between corporate bonds and government bonds?
Corporate bonds generally have a higher risk of default than government bonds
What are mortgage bonds?
Bonds secured by a mortgage on the company’s assets
What are floating-rate securities?
Corporate issues that automatically adjust to changing interest rates
Define domestic bonds.
Bonds issued in the currency and country of the issuer
Fill in the blank: Foreign bonds are issued outside of the issuer’s country and denominated in the _______.
[currency of the country in which they are issued]
What are domestic bonds?
Bonds issued in the currency and country of the issuer
Example: Bonds issued by a Canadian corporation in Canadian dollars.
What distinguishes foreign bonds from domestic bonds?
Foreign bonds are issued outside of the issuer’s country and denominated in the currency of the country where they are issued
Example: A Canadian company issuing bonds in U.S. dollars in the U.S. market.
What are Yankee bonds?
Foreign bonds issued by a foreign entity in the U.S. market, denominated in U.S. dollars.
What are Samurai bonds?
Foreign bonds issued by a foreign entity in Japan, denominated in yen.
What are Maple bonds?
Foreign bonds issued by a foreign entity in Canada, denominated in Canadian dollars.
What are foreign pay bonds?
Bonds that offer interest payments in one currency and principal in another.
What are Eurobonds?
International bonds issued in a currency other than the currency of the country where the bond is issued.
What are EuroCanadian bonds?
Eurobonds denominated in Canadian dollars.
What are Eurodollar bonds?
Eurobonds denominated in U.S. dollars.
What is a collateral trust bond?
A bond secured by a pledge of securities or collateral, typically issued by companies with few fixed assets.
What are equipment trust certificates?
Bonds that pledge equipment as security instead of real property.
Fill in the blank: Subordinated debentures are ______ to other securities issued by the company.
junior
What is a corporate note?
A short-term unsecured promise made by a corporation to pay interest and repay borrowed funds.
What are high-yield bonds?
Bonds considered non-investment grade with a higher risk of default, typically paying higher coupons.
What is commercial paper?
An unsecured promissory note issued by a corporation or an asset-backed security backed by financial assets.
What are term deposits?
Deposits offering a guaranteed rate for a short-term period, usually up to one year.
What are guaranteed investment certificates (GICs)?
Investments offering fixed rates of interest for a specific term, with guaranteed principal and interest payments.
What is an escalating-rate GIC?
A GIC where the interest rate increases over the term of the investment.
What is a laddered GIC?
A GIC investment divided into multiple-term lengths to reduce interest rate risk.
What is an instalment GIC?
A GIC requiring an initial lump-sum contribution with further contributions made periodically.
What is an index-linked GIC?
A GIC that provides returns linked to a market index, guaranteeing the return of the initial investment.
What is a fixed-income mutual fund?
A managed product providing access to a diversified portfolio of debt securities.
What is a typical bond quote format?
Includes issuer, coupon rate, maturity date, bid price, ask price, and yield to maturity.
What do investment-grade bonds indicate?
Bonds issued by high-quality issuers with adequate credit quality for financial obligations.
True or False: Ratings classify securities from investment grade to speculative.
True
What is the highest rating on Moody’s long-term rating scale?
Aaa
What rating indicates obligations with moderate credit risk on Moody’s scale?
Baa
What is the lowest rating on Moody’s long-term rating scale?
C
