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Series 7- Passed with 83% > Chapter 2- Debt Securities 15-25 questions > Flashcards

Chapter 2- Debt Securities 15-25 questions Flashcards

1
Q

Most common issuers of debt securities

A

Corporations, Municipalities and Us government

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2
Q

Senior security

A

Bondholders are considered senior because they are settled before common stock

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3
Q

Funded debt

A

Corporate bond with 5+ years till maturity

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4
Q

Treasury bill or note or bond

A

Bills are less than a year while notes are 2 to 10 year maturities.

Bonds are 10 or more years

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5
Q

Interest on a bond

A

Called the coupon rate

The interest rate is calculated from the par value or face value

Usually 1000 per bond

Interest on a bond accrues daily

Final bond semiannual interest is paid when bond matures with original amount

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6
Q

How to read a bond sale:

5M ABC J&J 15 8s of ‘21

A

5 1,000 dollar bonds

ABC is the issuer

January 15 and July 15

8% annually

Principal repaid in 2021

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7
Q

Three basic types of bond maturity

A

Term- Principal of the whole issue repaid on a maturity date. Issuers will establish a sinking fund to retire bonds.

Serial- Principal to mature at intervals over a period of years.

Balloon- pays part of issue off before maturity and makes lump sum payment at term

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8
Q

Basic bond info

A 
Name of issuer
Interest rate and payment date
Maturity date
Call features
Principal amount
CUSIP
Dated date (interest starts to accrue)
Reference to bond indenture
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9
Q

Bearer bond (coupon)

A

Used to be sold normally

Would clip coupons and collect interest for the bond from the company

No longer issued, no name was on bond

Were not registered so the holder could do what they pleased with them

Deliver to paying agent to receive interest

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10
Q

Fully registered

A

Records the principal and interest the bond has

Transfer agent Issues a new one upon sale to another customer

Receive a physical certificate of the bond

Issued in 1000 denominations or multiples of 5000 up to 100,000

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11
Q

Book entry bonds

A

Do not receive certificates rather the trade confirmation acts as the certificate

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12
Q

Primary issues determining price of a bond

A
  1. Issuers financial stability

2. Overall trends in interest rates

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13
Q

Pricing bonds

A

Bonds are usually priced in 1/8ths increments

So a bid of 98 1/8 means a bond is worth 98.125

1 basis point is either .01% or .0001 of a dollar

80 Bp is .8% or $8 on a 1000 face value bond

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14
Q

Standard and Poors Ratings

Moody’s ratings

A

SP- give either a + for the top half of a category or - for bottom half
Ratings listed top to bottom:
AAA, AA, A, BBB, (non invest grade) BB, B, C, D

Moody’s- Adds numerical qualifiers to indicate where a bond is within a category such as 1, 2, 3

A1 and Baa1 to indicate high quality within two categories

Moody’s also provides ratings on short term munis designated MIG 1-4 and SG (speculative)
Aaa, Aa, A, Baa (below is speculative), Ba (could miss), B (missed 1 or more payments), Caa (no interest being paid), D (Default)

No rating does not reflect poorly, as most issues are too small to justify the expense

Mood Swings is a creative way to remember as Moody’s uses both upper case and lower case letters

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15
Q

Basis for bond ratings

A 
Amount and comp of debt
Stability of cash flow
Ability to meet payment schedule
Asset protection
Management capability
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16
Q

Bank grade bonds

A

Rating of BBB or Baa and up

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17
Q

Ranking of safety in bonds

A

US gov Securities and series EE OR HH bonds
Gov agency though US gov does not officially back
Municipal issues (general obligation bonds protected by taxation while revenue bonds are backed by facility revenues)
Corporate debt usually ranked (Secured bonds, debentures, subordinated debentures, income bonds)

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18
Q

Debt service

A

Shcedule of interest and principal payments due on bond issue

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19
Q

Sinking fund

A

Facilitates the retirement of bonds

Can be used to call bonds, redeem bonds at maturity or buy back bonds

Makes bonds more marketable if low rated

Usually required by the trust indenture

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20
Q

Call feature

A

Redemption before maturity date either wholly or partial

Issuer notifies bondholders that it will call bonds at particular price

Partial calls are selected by lottery

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21
Q

Call premium

A

The difference between the call price and the par for the bond

If callable at 102, call premium is two points or $20 per bond

A point is $10

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22
Q

Term bonds vs serial bonds

Tender

A

Term bonds are called by random drawing

Serial bonds are usually called in inverse order of their maturities because longer maturities tend to have higher interest rates. This lowers the overall interest rate

If no call option is available, the bond is usually tendered

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23
Q

Call risk

A

Generally, a bond is only called when interest rates decrease

Usually a newly issued bond has a 5-10 year window of call protection

24
Q

Refunding

Pre refunding

A

Practice of raising money to call a bond or selling new bonds to close old ones

Common when maturity is approaching

Pre refunding is doing the raising before the call is ready to lock in a lower interest rate

AAA rated, escrowed in government securities

Form of defeasance, or termination, of an issuers obligation. DO NOT COUNT AS ISSUERS DEBT.

25
Q

Putable bonds

A

The investor has the right to sell the bond to the issuer at full face.

Must take a lower interest rate to get feature

Municipal bonds sometimes do this

26
Q

Nominal yield vs current yield

A

Coupon yield set at issuance

Current yield is coupon payment / market price

Price and yield are inverse

27
Q

Yield to maturity formula

A

Reflects the annualized return of the bond if held to maturity. Difference between price paid for bond and par value are taken into effect

Minus if premium, plus if discount

Annual Interest -/+ (premium or discount / years to maturity)
Divided by
Average price of the bond (price paid + original / 2)

Example
Bought at 800, coupon of 8%, 5yrs left

80 - (200 / 5) divided by 900 = 4.4% return due to purchasing at premium

Trading at a basis is referring to the yield to maturity

28
Q

Yield to call

A

Reflects the early redemption date

The sooner a bond is called, the sooner a premium is lost

YTC is always lower than yield, current yield and YTM if bought for a premium and sold at par

29
Q

Ranking Yields highest to lowest for a:

Discount

Premium

A

Discount: YTC, YTM, CY, Nominal Yiled (coupon)

Premium: Nominal Yield, Current Yield, Yield to Maturity and Yield to Call

This is due to the time span at which they would be called and how the different yields are calculated

30
Q

Yield Curve

A

The difference between short term and long term bonds with the same quality

31
Q

Normal Yield Curve

A

Yields typically differs by about 3% or 300 basis points in the total Curve.

If rates are expected to dip, long term bond yields drop lower in anticipation while short term remain the same. Creates an inverted yield curve.

If rates are expected to increase, the opposite will occur

32
Q

Yield curve predicting recessions and expansions

A

If the gap between corporate bonds and gov bonds increases, a RECESSION! might be coming due to investors seeking safety

If it’s narrowing, then an economic expansion may be forming as investors are willing to take risk

33
Q

Relationship between bonds and rates

A

If interest rates rise, bond prices will decrease to meet market demand

If given two discount bonds, the deeper discounted bond will appreciate most with interest rates decreasing

34
Q

Mortgage bonds

A

Have the highest priority claim on assets pledged as collateral.

Tend to have multiple issues so the first issued would have highest claim

35
Q

Open end indentures

A

Allows a company to issue more bonds on the same asset at a later date

36
Q

Collateral trust bonds

A

Bonds secured by securities held by a corporation of another.

The corporation issuing the bonds must then hold the securities for the bonds

Can be backed by subsidiaries stock or obligations of corp clients as well

37
Q

Equipment Trust Certificates

A

Used to finance capital equip

Has a serial retirement schedule that is set at the same rate as the depreciation of the asset

38
Q

Debentures

A

Backed by general credit of the corporation

Owners of the bonds are considered general creditors

Above subordinated debentures and preferred stock in chain

39
Q

Subordinated debentures

A

Last of all debt obligations in liquidation (still above preferred stock)

Often have conversion features

40
Q

Liquidation claim order

A 
Unpaid wages
IRS
Secured debt
Unsecured liabilities (includes debentures)
Subordinated debt 
Preferred stock
Common shareholders
41
Q

Income bonds (adjustment bonds)

A

Bonds issued by a company that is coming out of bankruptcy

Will only pay interest if corporation has income to meet interest payments

Do not accumulate for future payments

Not suitable for investors seeking income

42
Q

Zero-Coupon Bonds

A

Issued at a deep discount without a regular interest payment

Return is the difference between the sale price and maturity

Substantially more volatile, fluctuate wildly with market rate changes

Taxed on the accretion of the bond even though they do not pay interest

IRS requires accretion of the discount on an annual basis, cost basis also goes up with each year

43
Q

What security has no reinvestment risk?

A

Zero coupon bond, because it locks in a return

44
Q

Trust indenture act of 1939

A

If a corporate bond is over $50 million, it must be issued under a trust indenture

Trust indenture is a legal contract between bond holder and trustee, not automatically supplied

Federal and municipal bonds are exempt

45
Q

Trustee

A

Usually a commercial bank or trust company

Monitors covenants of the indenture

46
Q

Closed end covenants vs open end

A

Have senior claim on the underlying assets, sometimes called senior lien bonds

Open- permits subsequent issues to be secured by same property

47
Q

NYSE

A

Central marketplace for trading corporate bonds

NYSE Bonds also provides investors with a cost effective, autonomous way to trade

Most still trade in OTC market

48
Q

Convertible bonds

A

Bond that is able to be converted into a fixed amount of common shares

Pay lower interest rates, trade in line with common stock, have fixed interest payment and maturity dates so less volatile than common stock

More stable pricing if stock devalues

49
Q

Advantage of Convertibles for issuer

Disadvantages

A

Can be sold with lower coupon

Can eliminate fixed interest rate upon conversion

Does not have an adverse impact on stock price due to conversion happening over time

Disadvantages:
Shareholders equity is diluted when converted

Substantial conversion could cause voting problems

Loss of leverage in conversions

Interest is deductible so conversion increases tax liability

50
Q

Conversion ratio

A

Expressed the number of shares of stock a bond may be converted into

Conversion price of $40, face of $1000

25:1 conversion ratio

Stated in the indenture agreement

Preferred stock usually has a face of $100

Convertible bonds are protected by an antidilution covenant. Conversion price changes with a stock split or stock dividend

51
Q

Parity

A

The two securities are worth the same price

Market price of bond
/ = parity price
Conversion ratio (Shares)

Market price of common x conversion ratio=
Parity price

52
Q

Forced conversion

A

Issuer calls the bonds and it is in the best interest of bondholders to convert

If market price for the bond is selling at a premium to the conversion price, the market will quickly remove the premium after conversion is announced

53
Q

Reverse convertibles

A

Imbedded put options allows the bond issuer to convert the bonds to common stock at predetermined date

Higher interest rate for the bond holder

54
Q

Used to back collateralized loan obligations

A

Freddie Mac
Ginnie Mae
Fannie Mae

55
Q

Wall Street journal quoting

A

The Wall Street journal quotes yield as current yield

56
Q

Corporate bonds

A

Quoted as a percentage of par in 1/8ths

Series 7- Passed with 83% (19 decks)

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