Chapter 5 - Bonds Flashcards
(21 cards)
What is a bond?
A bond is a debt instrument where an investor lends money to an entity (such as a company or government) for a defined period at a fixed interest rate.
Why are bonds issued?
To raise capital for various purposes like funding operations, projects, or refinancing existing debts.
Who are the two major issuers of bonds?
- Companies (corporate bonds)
- Government (Government bond/ gilt)
What is the nominal value of a bond?
-The amount to be repaid to the bondholder at maturity.
What is the coupon of a bond?
The interest rate applied to the nominal value, representing periodic interest payments to the bondholder.
What is the maturity date (redemption date) of a bond?
-The date on which the bond’s nominal value is to be repaid to the investor.
Price of a bond?
-The market value of the bond, typically quoted per £100 of nominal value
What is a yield on a bond?
The return on investment from the bond, expressed as an annual percentage.
What is the flat yield of a bond?
It is calculated by dividing the annual coupon by the bond’s current market price.
What is “Yield to maturity” or (Redemption Yield)
Considers both the annual coupon payments and any capital gain or loss if the bond is held to maturity.
What is the relationship between yields and bond prices?
-Bond prices and yields have an inverse relationship. If interest rates rise, bond prices fall, leading to higher yields, and vice versa.
Are bonds tradable?
Yes, they can be bought and sold in the secondary market before maturity.
Advantages of Bonds
-Regular income through interest payments
-Predictable return if held to maturity
Disadvantages of bonds
-Credit risk: issuer may default
-Interest rate risk: Bond prices inversely related to interest rates.
Credit rating industries
-Assess the creditworthiness of bond issuers
-Ratings range from investment grade to non-investment grade.
What are the credit ratings for Moody’s ratings?
Investment Grade:
Aaa
Aa
A
Baa
Non-investment grade:
Ba
B
Caa
Ca
C
D
What are the credit ratings for Fitch and S&P?
Investment grade:
AAA
AA
A
BBB
Non-investment grade:
BB
B
CCC
CC
C
C
What is Leverage?
Leverage refers to the use of borrowed money (debt) to increase the potential return of an investment
Why use leverage?
-Enhance returns on equity -if returns from investment exceed cost of debt then shareholder returns are boosted.
-Avoid dilution of ownership.
-Tax benefits - Interest payments on debt are tax-deductible, reducing the effective cost of borrowing.
Common Leverage Ratios
Debt-to-equity ratio = Total debt/ total equity
Interest coverage ratio = EBIT (Earnings before interest and tax) / Interest expense
Risks of leverage
-Increased financial risk
-Default and insolvency
-Reduced flexibility
-Credit rating impact
