week 5 - book materials

Question 1

what is a bond?

Answer 1

a certificate that is a promise to pay money in the future

Question 2

why a company uses bond to get money from investors?

Answer 2

-using bond helps the liquidity of the market: different small investors can invest
-risk transformation
-maturity transformation

Question 3

what is the difference between treasury bills and treasury bonds?

Answer 3

treasury bills are less than one year, while treasury bonds are more than 1 year

Question 4

how is the default risk referred to in bonds?

Answer 4

credit risk

Question 5

what is the difference between the coupon rate and the discount rate?

Answer 5

They are indeed both interest rates but the coupon rate is concerned with the cash to be paid by the borrower and the discount rate is the interest rate applied by the investor in valuing the bond

Question 6

when is the par value the same as the present value?

Answer 6

when the coupon rate is equal to the discount rate

Question 7

how do floating rate bond works?

Answer 7

the coupon rate is adjusted every x time based on some market rate.

Question 8

what are consols bonds?

Answer 8

bonds with no maturity date: the coupon rate will be paid forever and the bond is valued as a perpetuity

Question 9

what are PIK bonds?

Answer 9

bonds that don’t pay cash coupons but pay coupons that consist in additional bonds

Question 10

what is a call bond?

Answer 10

bonds that give the issuing company the right to buy back the bonds, usually at an amount higher than the par value (this additional sum is called “call premium”)

Question 11

what is a refunding operation? (relatively to bonds)

Answer 11

Suppose a company sold bonds when interest rates were relatively high. Provided the issue is callable, the
company could sell a new issue of low yielding securities if and when interest rates drop. It could then use the
proceeds of the new issue to retire the high rate issue and thus reduce its interest expense.

Question 12

callable bonds have higher coupon rate than other bonds without it T/F

Answer 12

True

Question 13

what is a super poison put bond?

Answer 13

some bonds have a covenant called a super poison put, which enables a bondholder to turn in, or put, a bond back to the issuer at par in the event of a takeover, merger or major recapitalization.

Question 14

what is a make-whole call provision?

Answer 14

This allows a company to call the bond, but it must pay a call price that is essentially equal to the market value of a similar non-callable bond. This provides companies with an easy way to repurchase bonds as part of a financial restructuring, such as a merger.

Question 15

what is a convertible bond? how does their value differ from normal bond?

Answer 15

bonds that can be converted into a fixed number of shares of ordinary stock. The investors are willing to accept a lower coupon rate, since if the company does well the investors can convert the bond into shares.

Question 16

warrants bonds have a lower coupon rate than straight bonds T/F

Answer 16

True, Warrants are options that permit the holder to buy stock at a fixed price, thereby providing a gain if the price of the stock rises. Some bonds are issued with warrants. As with convertibles, bonds with warrants have lower coupon rates than straight bonds.

Question 17

what are income bonds?

Answer 17

An income bond is required to pay interest only if earnings are high enough to cover the interest expense. If earnings are not sufficient, then the company is not required to pay interest and the bondholders do not have the right to force the company into bankruptcy. Therefore, from an investor’s standpoint, income bonds are riskier than ordinary bonds.

Question 18

what are the so called indexed bonds? (or purchasing power bonds?)

Answer 18

The interest payments and maturity payment rise automatically
when the inflation rate rises, thus protecting the bondholders against inflation.

Question 19

what does the “rolling over debt” action means?

Answer 19

when a company issues a bond to pay off the first bond issued.

Question 20

The longer the time to maturity of the bond, the more sensitive the price to changes in the interest rate.
T/F

Answer 20

True

Question 21

what is the duration?

Answer 21

The measure of sensitivity to interest rate changes is termed durationand
as a measure it takes into account the yield and the coupon rate though years to maturity is the dominant factor.

Question 22

The higher the yield (rate of return, discount factor), the _____ the bond price.

Answer 22

Lower

Question 23

Long term bonds have _____ risk.

Answer 23

greater

Question 24

Higher coupon bonds have _____ risk.

Answer 24

less

Question 25

the difference between long and short term bonds _______ over time

Answer 25

diminishes

Question 26

a fall in the yield will result in a ____ _____ in the value of the bond than an increase in the yield (fall)

Answer 26

larger rise

Question 27

what is a mortgage bond and what is a debentures bond?

Answer 27

A mortgage bond is a type of debt security that is secured by a mortgage or a pool of mortgages.
A debenture is an unsecured bond, and as such it provides no lien against specific property as security for the obligation.

Question 28

what are the rating criteria regarding bonds?

Answer 28

financial ratios, bond contract terms, qualitative factors

Question 29

what is a bond spread?

Answer 29

A bond spread is the difference between a bond’s yield and the yield on some other security of the same
maturity. Unless specified differently, the term spread generally means the difference between a bond’s yield
and the yield on a treasury bond of similar maturity.

Question 30

what are the fallen angels bond?

Answer 30

they are bonds whose rating has declined due to hard times.