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ba 141 - finance > Module 5 - Interest Rates and Bond Valuation > Flashcards

Module 5 - Interest Rates and Bond Valuation Flashcards

1
Q

It is usually applied to debt instruments such as bank loans or bonds

A

Interest rate

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2
Q

it is the compensation paid by the borrower of funds to the lender

A

interest rate

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3
Q

it is usually applied to equity instruments such as common stock

A

required return

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4
Q

the cost of funds obtained by selling an ownership interest

A

required return

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5
Q

the cost of funds obtained by selling an ownershp interest

A

required return

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6
Q

a company that plans a plant expansion can obtain financing either through:

A

debt or equity

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7
Q

if the company issues bonds, they would have to pay the creditors the principal at a specified time

A

obtain financing through debt

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8
Q

some companies raise capital through the issuance of shares

A

cimpanies obtaining financing through equity

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9
Q

it is money lent at an interest rate for a certain period of time

A

Loan

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10
Q

Content of a Loan Agreement: part of legal documentation. intended to protect investors by providing assurance on what the borrower will do or won’t do over the life of the bond

A

Covenants

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11
Q

Content of a Loan Agreement: Pledge agreement, security agreement

A

Collateral

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12
Q

Content of a Loan Agreement: Lump sum, semi-annual, monthly, etc.

A

Term of loan

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13
Q

Content of a Loan Agreement: Provision in most loan and insurance contracts which allows payment to be received for a certain period of time after the actual due date

A

Grace Period

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14
Q

Content of a Loan Agreement: during this period, no late fees will be charged, and the late payment will not result in default or cancellation of the loan

A

Grace Period

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15
Q

also a form of loan but can be traded through PDEX

A

Bond

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16
Q

PDEX

A

Philippine Dealing and Exchange (PDEX) System

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17
Q

True or False: the cost of equity is generally higher than the cost of debt.

A

True

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18
Q

why is the cost of equity generally higher than the cost of debt

A

since equity investors take on more risk when purchasing a company’s stock as opposed to a company’s bond. therefore, an equity investor will demand higher returns

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19
Q

Factors that influence the Equilibrium interest rate (3)

A
  1. Inflation
  2. Risk
  3. Liquidity preference
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20
Q

Factor the influence EIR: rising trend in the prices of most goods and services, investors would demand higher returns to compensate for decreased purchasing power

A

Inflation

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21
Q

Factor the influence EIR: Higher __ lead investors to expect a higher return on investment.

A

Risk

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22
Q

Factor the influence EIR: General tendency of investors to prefer short-term securities because they are more liquid and involve relatively lower risk

A

Liquidity Preference

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23
Q

The rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world

A

real rate of interest

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24
Q

represents the most basic cost of money, changes with changing economic conditions, tastes, and preferences

A

real rate of interest

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25
Q

the actual rate of interest charged by the supplier of funds and paid by the demander

A

nominal interest rate

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26
Q

also known as actual interest rate

A

nominal interest rate

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27
Q

the nominal rate differs from the real rate of interest as a result of two factors:

A
  1. inflation premium

2. risk premium

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28
Q

the ____ rate embodies the real rate of interest plus the expected inflation premium

A

risk-free rate

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29
Q

the relationship between the maturity and rate of return for bonds with similar levels of risk

A

term structure of interest rates

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30
Q

the term structure of interest rates is depicted graphically in a:

A

yield curve

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31
Q

tells analysts how rates vary between short, medium, and long-term bonds. also provides information on where interest rates and the economy are headed in the future

A

yield curve (term structure of interest rates)

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32
Q

determined by the equilibrium between supplier and demanders of short-term funds

A

short-term interest rates

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33
Q

determined by the equilibrium between supplier and demanders of long-term funds

A

long-term interest rate

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34
Q

an upward sloping yield curve that indicates that long-term interest rates are generally higher than short-term interest rates

A

normal yield curve

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35
Q

a downward sloping yield curve that indicates that short-term interest rates are generally higher than long-term interest rates.

A

inverted yield curve

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36
Q

a yield curve that indicates that interest rates do not vary much at different maturities

A

flat yield curve

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37
Q

three theories that are frequently cited to explain the general shape of the yield curve

A
  1. expectations theory
  2. liquidity preference theory
  3. market segmentation theory
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38
Q

theory that the yield curve reflects investor expectations about future interest rates

A

expectations theory

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39
Q

expectations theory: an expectation of rising interest rates results in ____ sloping yield curve; an expectation of declining rates result in ____ sloping yield curve

A

upward; downward

40
Q

a theory that suggests that long term rates are generally higher than short-term rates because investors perceive short-term investments to be more liquid and less risky than long-term investments

A

Liquidity Preference Theory

41
Q

this theory is n explanation for the upward-sloping yield curve

A

liquidity preference theory

42
Q

in liquidity preference theory, Investors generally prefer to buy _____ securities, while issuers/borrowers prefer to sell _____ securities (longer time to pay for debt)

A

short-term, long-term securities

43
Q

this theory suggests that the market for loans is totally segmented on the basis of maturity and that the supply of and demand for loans within each segment determine its prevailing interest rate

A

market segmentation theory

44
Q

in market segmentation theory, this curve indicates greater borrowing demand relative to the supply of funds in the long-term segment of the debt market relative to the short-term segment

A

upward-sloping yield curve

45
Q

to calculate the risk premium of other securities

A

subtract Treasury bond (risk-free rate) to other securities

46
Q

the possibility that the issuer will not pay the contractual interest or principal as scheduled

A

default risk

47
Q

the longer the maturity, the more the value of a security will change in response to a given change in interest rates

A

Maturity (interest rate) risk

48
Q

conditions that are often included in a debt agreement or a stock issue

A

contractual provisions

49
Q

corporate bonds: amount borrowed by the company and amount owed to the bondholder on the maturity date

A

par (face) value

50
Q

corporate bonds: time at which a bond becomes due and the principal mus be repaid

A

maturity date

51
Q

corporate bonds: percentage of a bond’s par value that will be paid annually, typically in two equal semiannual payments, as interest

A

coupon rate

52
Q

long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it n the future under clearly defined terms

A

corporate bond

53
Q

two legal aspects of corporate bonds

A

standard debt provisions and restrictive covenants

54
Q

legal aspect of corporate bonds: specify certain record-keeping and general business practice that the bond issuer must follow

A

Standard Debt Provisions

55
Q

corporate bonds: normally include restrictive covenants, place operating and financial constraints on the borrower

A

Restrictive Covenants

56
Q

a legal document that specifies both the rights of the bondholders and the duties of the issuing corporation

A

bond indenture

57
Q

most common restrictive covenants: (6)

A

require minimum liquidity level

  1. prohibit sale of accounts receivable
  2. impose fixed-asset restrictions
  3. constrain subsequent borrowing
  4. limit annual cash dividend payments
58
Q

cost of bonds to issuer: the longer the bond’s maturity, the ____ he interest rate to the firm

A

maturity

59
Q

cost of bonds to issuer: the larger the size of the offering, the ___ will be the cost of the bond

A

lower

60
Q

cost of bonds to issuer: the greater the default risk of the issuing firm, the ___ the cost of the issue

A

default risk

61
Q

cost of bonds to issuer: the cost of money in the capital market is the basis for determining a bond’s __________ rate

A

coupon interest rate

62
Q

the rate of interest paid by the bond issuer

A

cost of bonds to issuer

63
Q

general features of a bond issue: (3)

A
  1. conversion feature
  2. call feature
  3. stock purchase warrants
64
Q

general features of a bond issue: allows bondholders to change each bond into a stated number of shares of common stock

A

COnversion feture

65
Q

general features of a bond issue: call feature

A

gives the issuer the opportunity to repurchase bonds prior to maturity

66
Q

general features of a bond issue: gives holders the right to buy a certain number of shares of the issuer’s common stock

A

Stock purchase warrants

67
Q

when the amount by which a bond’s call price exceeds its par value, it is equal to one-year coupon interest and compensates the holder for having it called prior to maturity.

A

call premium

68
Q

three most widely cited yields: (3)

A
  1. current yield
  2. yieldto maturity
  3. yield to call
69
Q

bond yields: a measure of a bond’s cash return for the year; interest payment divided by the current price

A

current yield

70
Q

bond yields: compound annual rate of return earned on a debt security purchased on a given day and held to maturity

A

Yield to maturity

71
Q

bond yields: yield of the bond if you were to buy and hold the security until call date

A

Yield to call

72
Q

___ yield: typically involves equity market, dividend income, and stock price

A

Current yield

73
Q

_____ typically involves the bond market, coupon payment, and price vs. face value

A

Yield to Maturity

74
Q

assess the riskiness of publicly traded bond issues

A

Independent rating agencies

75
Q

evaluate and attach ratings to credit instrumnts

A

Cret-rating agencies

76
Q

Types of Bonds - Unsecured: (3)

A
  1. Debenture
  2. Subordinated debenture
  3. Income bonds
77
Q

Types of Bonds - Unsecured: bonds that only creditworthy firms can issue; claims are the same as those of any general creditor

A

Debenture

78
Q

Types of Bonds - Unsecured: claims are not paid until senior debts have been fully satisfied; claim is that of a general creditor but not as good as a senior debt claim

A

Subordinate debenture

79
Q

Types of Bonds - Unsecured: payment of interest is required only when earnings are available; claim is that of a general creditor

A

Income bonds

80
Q

Types of Bonds - Secured (3):

A
  1. mortgage bonds
  2. collateral trust bonds
  3. equipment trust certificates
81
Q

Types of Bonds - Secured: secured by real estate or buildings; claim is on proceeds from sale of mortgaged assets

A

Mortgage bonds

82
Q

Types of Bonds - Secured: secured by stock and/or bonds; claim is on proceeds from stock and/or bond collateral

A

collateral trust bonds

83
Q

Types of Bonds - Secured: used to finance rolling stock”; claim is on proceeds from the sale of the asset

A

Equipment trust certificates

84
Q

process that links risk and return to determine the worth of an asset

A

Bond valuation

85
Q

three key inputs to the valuation process

A
  1. cash flows (returns)
  2. timing
  3. a measure of risk, which determines the required return
86
Q

in general, the greater the risk of (or the less certain a cash flow, the _____ its value.

A

lower

87
Q

the higher the risk, the ____the required return, and the lower the risk, the _____ the required return

A

higher, lower

88
Q

the value of any asset is the _____ value of all future cash flows it is expected to provide over the relevant time period

A

present

89
Q

it is equal to the cash flows (CF) expected at the end of year n

A

Future Value

90
Q

true or false: the bond price would be the present value of cash flows, the payments the issuer is contractually obligated to make until maturity which would include the interest payments and the principal

A

true

91
Q

contract rate > market rate

A

bond sells at a premium

92
Q

contract rate = market rate

A

bond sells at par

93
Q

contract rate < market rate

A

bond sells at discount

94
Q

contract rate is sometimes called:

A

coupon rate, stated rate, and nominal rate

95
Q

increase in the basic ost of long-term funds o in in risk will ____ the required return; decreases in cost of funds or in risk will _____ the required return

A

raise, lower

ba 141 - finance (4 decks)

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