Chapter 5 Bonds Flashcards
(19 cards)
DuPont System of Analysis
DuPont System of Analysis is an integrative approach used to dissect a firm’s financial statements and assess its financial condition
It ties together the income statement and balance sheet to determine two summary measures of profitability, namely ROA and ROE
In the DuPont System the firm’s return is broken into three components
A profitability measure (net profit margin)
An efficiency measure (total asset turnover)
A leverage measure (financial leverage multiplier)
Bond indenture
Major provisions/ agreement
Over 100 pages long
Complicated legal document
Administered by a trustee
(usually a commercial bank)Par value
Face value of a bond
Corporate: $1,000
Fed, state, & local: $5,000 or $10,000
Sinking-fund
Semiannual or annual contributions by the bond issuer into a fund run by a trustee for the purposes of debt retirement
Debenture
Unsecured corporate debt issue
Higher yields due to higher risk
Features of Preferred Stock
Convertible
May be converted into common stock
Callable
Generally slightly above par
Cumulative
If dividends not paid in any year, they accumulate and must be paid before common shareholders receive any cash dividend
Nominal Yield
Measures the coupon rate
Current yield
Measures current income rate
Promised yield to maturity
Measures expected rate of return for bond held to maturity
Promised yield to call
Measures expected rate of return for bond held to first call date
Realized (horizon) yield
Measures expected rate of return for a bond likely to be sold prior to maturity.
Expectations Theory
Term Structure and Capital Budgeting
CF should be discounted using term structure info
When rate incorporates all forward rates, use spot rate that equals project term
Take advantage of arbitrage
Expectations Hypothesis
Any long-term rate is an average of the expectations of future short-term rates over the applicable time horizon
Liquidity Preference Theory
The shape of the term structure curve tends to be upward sloping more than any other pattern.
Reflects recognition that long maturity obligations are subject to greater price-change movements when interest rates change
Market Segmentation Theory
Banks prefer short-term liquid securities
Life insurance companies prefer long-term bonds
These two institutions often put pressure on short-term and long-term rates
Bond Pricing Rules
Bond prices and interest rates are inversely related.
Prices of long-term bonds are more sensitive to change in YTM than short-term bonds.
Prices of low-coupon bonds are more sensitive to a change in YTM than high-coupon bonds.
Factors affecting default risk and bond ratings
Financial performance Debt ratio TIE ratio Current ratio Bond contract provisions Secured vs. Unsecured debt Senior vs. subordinated debt Guarantee and sinking fund provisions Debt maturity
Priority of claims in liquidation
Secured creditors from sales of secured assets. Trustee’s costs Wages, subject to limits Taxes Unfunded pension liabilities Unsecured creditors Preferred stock Common stock
