Bonds Flashcards Preview

CMA Part 2 > Bonds > Flashcards

Flashcards in Bonds Deck (40)
Loading flashcards...

What are bonds?

They are long-term debt financing (contractual obligation to pay face amount) for corporations and government entities. Issuing bonds requires extensive legal and accounting work, so it's rarely to see bonds with maturity of fewer than 10 years.


What is face amount (in terms of bond)?

It's also known as par value or maturity amount. This amount is received on the bond's maturity date.


What is annual cash interest (in terms of bond)?

Formula = face amount x stated rate


What is stated rate (in terms of bond)?

It's also called the coupon rate. It's the percentage used to calculate for cash interest payments for a bond.


What is indenture?

A legal contract/agreement stating the all the terms of debt.


What are advantages for issuing a bond?

1. Interest paid on debt is tax deductible (most significant advantage)
2. Basic control of the firm is not shared with debt holders


What are disadvantages for issuing a bond?

1. The firm can become insolvent if cash flow is insufficient to service debt
2. The legal requirement to pay debt service raises the firms' risk level
3. The long-term nature affects the firm's risk profile
4. Certain managerial rights are given up per the indenture (specific ratios must be kept higher)
5. Debt financing amount is limited to a firm (debt-equity ratio is usually dictated by the investment community)


What are debt covenants?

The restrictions or protective clauses imposed on borrowers in a formal debt agreement or an indenture.


List examples of debt covenants.

1. Limitations on issuing long or short-term debt
2. Limitations on dividend payments
3. Maintaining certain financial ratios
4. Maintaining specific collateral that backs the debt


What happens when the debtor breaches the debt covenant?

The debt becomes due immediately.


What are call provisions?

They allow bond issuers to exercise an option to redeem the bonds earlier than the specified maturity date.


What is a bond sinking fund?

It requires the issuer to make payments into the fund to segregate and accumulate sufficient assets to pay the bond principal at maturity.


What is a term bond?

It has a single maturity date at end of the term.


What is a serial bond?

It matures in stated amounts at regular intervals.


What is a variable rate bond?

It pays interest that is dependent on the market conditions.


What is a zero-coupon (deep-discount) bond?

It bears no stated interest rate and thus involves no periodic cash payments. The interest component consists entirely of the bond's discount.


What is a commodity-backed bond?

It's payable at prices related to a commodity (i.e. gold).


What is a callable bond?

It may be repurchased by the issuer at a specified price before maturity. It is not as valuable as a straight bond to investors.


What is a convertible bond?

It may be converted to equity (stock) of the issuer at the option of the holder under certain conditions.


What is a mortgage bond?

It is backed by specific asset, usually real estate.


What is a debenture?

It's backed by issuer's full faith and credit.


What is an equipment trust bond?

It's secured by a lien on a specific piece of equipment (i.e. airplane). It's used mostly in the transportation industry.


What is a registered bond?

It's issued in the name of the holder so only the registered holder may receive interest and principal payments.


What is a bearer bond?

It's not individually registered so anyone who presents the bond can receive interest and principal payments.


What are subordinated debenture and second mortgage bond?

They are junior securities with claims inferior to those of senior bonds.


What is an income bond?

It pays interest only when the issuer earns interest.


What is a revenue bond?

It's issued by government entities and is payable from specific revenue source.


What is the term structure of interest rates?

It's the relationship between yield and time to maturity. It's important to both corporate treasurer and investors for deciding whether to issue or buy short or long-term debt.


What are the four common yield curve?

1. Upward (typical; longer duration of a bond means more time there is for interest rate volatility to affect a bond's price)
2. Flat
3. Downward
4. Humped


What is interest rate risk?

It's the risk that an investment security will fluctuate in value due to changes in interest rates.