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Flashcards in BKM Chapter 14 Deck (69)
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Bond definition & components (2)

(BKM - 14)

type of debt security where the borrower (issuer/seller) compensates the lender (holder/buyer) for use of the cash

1. coupon payments - periodic interest payments
2. par value - face value of the bond


Zero-coupon bonds & pricing

(BKM - 14)

bonds that do not pay any coupons

usually sold at a price < par value with price converging to par value over time


Bond coupon payment

(BKM - 14)

coupon payment = coupon rate * par value


Ask vs. bid price for bonds

(BKM - 14)

ask = price you can buy a bond from a dealer
bid = price you can sell a bond to a dealer

generally ask price > bid price


Bond sale price

(BKM - 14)

Bond sale price = stated price (aka flat price) + accrued interest


Accrued interest definition & formula

(BKM - 14)

pro-rated portion of coupon for bonds sold between coupon payments

accrued interest = (annual coupon payment / # payments) * (# of days since last coupon payment / # days b/w coupon payments)


Unique bond features (10)

(BKM - 14)

1. callable bonds
2. puttable bonds
3. convertible bonds
4. floating-rate bonds
5. international bonds
6. inverse floating-rate bonds
7. asset-backed bonds
8. catastrophe bonds
9. indexed bonds
10. preferred stock


Callable bonds and relative riskiness

(BKM - 14)

optional bond feature where the issuer can re-purchase the bond for a specified call price before maturity

riskier for investors, so they typically have higher coupons and higher promised yields to compensate


When is it optimal to call callable bonds?

(BKM - 14)

desirable to call when interest rates are low (b/c it allows the bond to be refinanced at a lower interest/coupon rate)


Convertible bonds and relative riskiness

(BKM - 14)

bond feature where the bond is exchangeable for a specified number of shares of common stock

lower risk (lower coupons and promised yields) because of the potential future benefit


When is it desirable to convert convertible bonds?

(BKM - 14)

convert if current stock price > par value / # shares


Puttable bonds

(BKM - 14)

bond feature where the bondholder can extend the bonds life at a specified date


When is it desirable to extend puttable bonds?

(BKM - 14)

extend if the coupon rate > market rate on the put date


Floating rate bonds & riskiness

(BKM - 14)

bond feature where coupon payments (interest rates) are tied to market rates

ex: coupon rate = current T-bill rate + 2% (spread)

more risky if the financial position of the firm worsens


Relationship between the coupon rate & the market rate for floating-rate bonds

(BKM - 14)

coupon rate increases as the market rate increases


International bonds & categories (2)

(BKM - 14)

bonds that are issued by a country other than the market they are sold in

1. foreign bonds - denominated in the currency of the country where they are sold (e.g. Germany sells dollar-denominated bond in the US)
2. Euro-bonds - denominated in a currency other than the country where they are sold (e.g. US firm sells a dollar-denominated bond in Germany)


Inverse floating-rate bonds (relationship b/w coupon rate & market rate)

(BKM - 14)

bond feature similar to floating rate bonds but where coupon rates fall when market rates increase


Asset-backed bonds

(BKM - 14)

bond feature where coupon payments are backed by income generated from a firm's assets

ex: mortgage-backed securities


Catastrophe bonds & relative riskiness

(BKM - 14)

type of bond that transfers catastrophe risk from the firm to the capital markets where the coupon payments are dependent on the occurrence of a CAT event (e.g. pays coupons up until a CAT event, then stops)

riskier for investors, so coupon rates are generally higher


Indexed bonds

(BKM - 14)

bond feature where coupon payments are tied to the price of a commodity or a price index

**coupon rate is fixed, but the par value changes each year based on actual price changes


Nominal rate of return for indexed bonds

(BKM - 14)

nominal ROR = (coupon + change in par value) / par value at BOP


Real rate of return for indexed bonds

(BKM - 14)

real ROR = (1 + nominal rate) / (1 + inflation rate) - 1

real ROR = coupon rate as long as the coupon rate is constant


Preferred stock

(BKM - 14)

technically an equity, but with fixed-income features such as dividend payments (which are similar to coupons)


Bond value (aka stated or flat price)

(BKM - 14)

bond value = PV(coupon payments) + PV(par value)


Relationship between bond value and par value when bonds are sold at a premium vs. a discount

(BKM - 14)

premium: bond value > par value

discount: bond value < par value


When does bond value = par value?

(BKM - 14)

when the coupon rate = interest rate


Characteristics reflected in a bond interest/discount rate (4)

(BKM - 14)

1. default risk
2. liquidity
3. tax attributes
4. call risk


Relationship between bond value, coupon rate, and interest/discount rate (2)

(BKM - 14)

all else equal:
1. bond value decreases as coupon rate decreases
2. bond value increases as interest/discount rate decreases


Reason short-term securities are generally considered to be less risky

(BKM - 14)

less sensitive to interest rate fluctuations


Biggest source of risk in the fixed-income market

(BKM - 14)

interest rate fluctuations