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FIN 3303 > Chapter 7 > Flashcards

Chapter 7 Flashcards

1
Q

Who issues bonds?

A
  1. US Federal Government
  2. US Corporations
  3. US State and local governments (aka “Municipal Bonds” or “Muni’s”
  4. Foreign Governments and Foreign Corporations.
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2
Q

What is a Bond?

A

Bonds are long-term financial (debt) instruments which are sold by large government and corporate issuers to raise a lot of money in a short period of time.

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3
Q

What is a Bond? (For the Issuer)

A

A Bond is a legal obligation (a liability or debt) to pay periodic interest payments each year and usually a single principal payment on the maturity date to the Buyer of the Bond.

The word “Bond” comes from the idea that the issuer is making legal commitments it is legally bound to perform.

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4
Q

What is a Bond? (For the Buyer)

A

A Bond is a legal claim (an asset) against the assets or income of the Issuer of the Bond equal to the periodic interest payments and usually a single principal payment on the maturity date to be received by the Buyer from the Bond Issuer.

The word “Bond” comes from the idea that the issuer is making legal commitments it is legally bound to perform.

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5
Q 
Key Characteristics of Bonds
Par Value (aka Face Value)
A

The denomination value for each individual bond in a bond issue. (FV)

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6
Q

Key Characteristics of Bonds

Maturity Date

A

Defines how long it will be before the bond issuer redeems the bond. (N)

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7
Q

Key Characteristics of Bonds

Investment Risks

A 
Includes: 
Inflation Risk
Maturity Risk
Default Risk 
Liquidity Risk

*the longer the term the more risks of defaulting.

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8
Q

Key Characteristics of Bonds

Yield-To-Matuirity (YTM)

A

Bond investors required rate of return, which can/does change over time. (I)

-Represents the current market of required rate of return

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9
Q

Key Characteristics of Bonds

Coupon Interest Rate

A

Determined by the initial investors YTM

-Established by investment banks.

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10
Q

Key Characteristics of Bonds

Coupon Interest Payment

A

Equal to coupon interest rate x par value, paid annually or semi-annually. (PMT)

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11
Q

Key Characteristics of Bonds

Price or Present Value

A

Current Market Price = Present value of all future cash flows. (PV)

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12
Q

Key Characteristics of Bonds

Bond Indenture

A

The contract that defines the legal obligations of the Bond Issuer and legal rights of the Bondholder; usually contains a number of Restrictive Covenants to help protect Bondholders interests.

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13
Q

Key Characteristics of Bonds

Trustee

A

Independent party hired by the Bond Issuer to represent the interest of the Bondholders, and may also serve as the Registrar and Paying Agent.

  • Provides bondholders trust.
  • Legal document sets legal commitment.
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14
Q

Treasury Bonds:

A

Bonds issued by the federal government, sometimes referred to as government bonds.

  • Treasuries have no default risks.
  • Bond Prices do decline when interest rates rise.
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15
Q

Corporate Bonds:

A

Bonds issued by corporations.

-Corporates are exposed to default risks, if company gets into trouble.

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16
Q

Municipal Bonds:

A

Bonds issued by state and local government.

  • Munis are exposed to some default risks.
  • Have one major advantage, interest earned on most Munis is exempt from federal taxes and from state taxes if the holder is a resident of the issuing state.
  • The market interest rate on a munis is lower than a corporate bond of equivalent risk.
17
Q

Assessing a Bond’s Riskiness: Interest Rate Risk

-Interest Rate Price Risk:

A

-The Longer the Term of the Bond, the greater the risk.
-The Lower the Coupon Interest Rate the greater the risk.
-If Investors’ YTM’s increase, then Bond Prices decrease.
(Vice Versa)

18
Q

Assessing a Bond’s Riskiness: Interest Rate Risk

-Interest Rate Re-Investment Risk:

A

-The Shorter the Term of the Bond, the greater the risk.

19
Q

Assessing a Bond’s Riskiness: Default Risk

-Name 3 Independent Credit Rating Agencies:

A
  1. Moody’s Investors Service
  2. Standard & Poor’s Rating Group
  3. Fitch Investors Service

Moody’s and Standard are largest agencies.
-Bond Issuers pay the Credit Rating Agencies a fee to have a Credit Rating assigned.

FIN 3303 (12 decks)

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