Chapter 6 part 1 from notes Flashcards Preview

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Flashcards in Chapter 6 part 1 from notes Deck (87):

Definition of bills or papers

short term bonds with a maturity of less than one year


Collateral trust bonds

bonds secured by a pledge of other financial assets, such as common shares, bonds or treasury bills


mortgage bonds

debt instruments that are secured by real assets


collateral trust bonds

bonds secured by a pledge of other financial assets, such as common shares, bonds or treasury bills



bonds with maturities b/w 1 and 7 years



long-term debt instruments that promise fixed payments and have maturities of longer than 7 years


who are the main bond issuers

- federal, provincial and municipal gov
- government agencies (eg Canada mortgage and housing corp, hydro Quebec)
- coroporation and on-resident issuers (maple bond market)


who are the main purchasers of bonds

institutional investors (insurance companies, pension funds and bond mutal funds)


a bond is what

any debt instrument that promises a fixed income stream to the holder until the maturity date


where do you find the promises of the bond

in a contract and are a fixed contractual commitment


how often do bonds pay interest or the coupon

semin-annually or annually and full principal payment at maturity


what is a bullet payment or balloon payment

- when the principal payment is made in one lump sum at maturity


what are bonds sometimes refered to as and why

fixed income securities
- because the interest payments and principal repayment are specified, or fixed at the time the bond is issued


if the buyer decides to sell the bond before maturity what happens to the price received

the price recived will depend on the level of interest rates at that time


How is a bond's structure different from a loan or mortgage

- beause it had blended payments (principal and interest)


a bond can be viewed as 2 separate components what are they

1. an annuity (consisting of identical and regular interest payments)
2. a lump sum payment a maturity


what is a bond indenture

a legal document that specifies the payment requirements and all other important matters relating to a particular bond issue, held and administered by a trust company


what is collateral

assets that can serve as security for the bond in case of default


what are covenant provisions

clauses within the indenture that lay out the legal rights of the bondholder and the obligations of the issuer


what is par value

also called face value or marturity value
- amount paid at marturity


what is term to maturity

time remaining to maturity date


what are interest payments or coupons

amounts paid on a bond at regular intervals


what is the par value on most bonds

although bond prices are typically quoted on par value of 100


if the price of a bond is quoted at $99,583, a $1,000 par value bond would be selling at what



How are interest payments or coupons determined

by multiplying coupon rate (stated on annual basis) by par value of the bond


a bond with a coupon rate of 6% and a par value of $1,000 would pay a coupon of

$60 annual or $30 every 6 months


what are mortgage bonds

debt instruments that are secured by real assets
- not all bonds are secured by real property


what are debentures

debt instruments similar to bonds but are generally unsecured or are secured by a general floating charge over the company's unencumbered assets (those assets that have not been pledged as security for other debt obligations)


what are some examples of debentures

gov bonds, because no specific security is pledged as collateral
- called bonds as a matter of convention


what are collateral trusts and bonds secured by

a pledge of other financial assets
such as common shares, bonds or treasury bills


what are equipment trust certificates

a type of debt instrument secured by equipment
- such as railway rolling stock


what are protective covenants

clauses in the trust indentrue that restricts the actions of the user
1. negative covenants
2. positive covenatns


what are negative covenants

restrict certain actions
- restrict a company form making a dividend payment over a ceratin amount
- or prevent them from pledging assets to another lender


what are positive covenants

specify actions that the firm agrees to undertake
- company may promise to provide quarterly f.s. or maintain certain working capital levels


what are some bond features or options

1. callable bonds, call prices, retractable bonds, extendible bonds, sinking fund provisions, purchase fund provisions, convertible bonds


what is a callable bonds

bonds that give the issuer the option to "call" or repurchase, outstanding bonds at predetermined prices at specified times


what are call prices

generally at a premium over par, at which issuers can repurchase bonds


what are retractable bonds

bonds that the bondholder can sell back to the issuer at a predetermined prices at specified times earlier than the maturity date


what are extendible bonds

bonds that allow the bond holder to extend the maturity date of the bonds


what are sinking fund provisions

the requirement that an issuer set aside funds each year to be used to pay off the debt at maturity


what are purchase fund provisons

the requirement that a certain amount of debt be repurchased only if it can be repurchased at or below a given price


what are convertible bonds

bonds that can be converted into common shares at predetermined conversion prices


how do you determine the price of a bond and what do you need to know

1. must know par value, term to maturity and coupon rate
2. use an appropriate discount rate to discount the bond (often called the market rate of interest)


what are the factors that affect the discount rate

1. function of market conditions (ie other market interest rates)
2. factors specific to issue and issuer


what is the price of the bond

the PV of the future, which is the PV of the interest payments and the par value repaid at maturity


what is a discount

difference b/w a bond's par value and the price it trades at when it trades below the par value


if the coupon rate is less than the market interest (discount) rate what is the bond trading at

a discount


because coupon rates are fixed, the only way to get a higher return is to

pay less than par value for it


what is par value

when market rate = coupon rate


what is premium

when market interest rates are below coupon rate


what are the factors affecting bond prices

1, interest rates
relationship b/w market rates and bond prices
3. relationship b/w coupon rate an dbond's ytm


if interest rates decrease

market prices of bonds increase and vice versa


the relationship between market rates and bond prices is

not linear; the curve is convex


interest rates are inversely related to bond prices

bond prices increase when interest rates decrease and vcie versa


the relationship b/w the coupon rate and the bond's YTM

determines if the bond will sell at a premium or a discount or par


if the coupon rate is greater than YTM

price is greater than face value = discount


if coupon rate = YTM

price = face value , par


if coupon rate Iess than YTM

prices is less than Face value = Preimum


what are the factors that affect bond prices

1. YTM
2. time to maturity
3. size of coupon
4. interest rate risk and duration


what affects the volatility of a bond

YTM, time to maturity and size of coupon


how does time to maturity affect a bond

long-maturity bonds have greater price volatility than short-maturity bonds
- the longer the bond, the longer the period for which the cash flows are fixed


how does the size of the coupon affect the bond

low coupon bonds have greater price volatility than high coupon bonds


what do high coupon bonds act like

a stabilizing device
- since a greater proportion of the bond's total cash flow occurs closer to today and are therefore the PV is less affected by a change in YTM


how does interest rate risk and duration affect the bond

sensitivity of a bond's price to change in interest rates is a measure of the bond's interest rate risk
- interest rate risk is affected by YTM, Term to Maturity, and size of coupon


the impact of interest rate risk is measured using



duration measures

of interest rate risk as a change in price for a given change in interest rates


a bond's duration will be higher if its:

- YTM is lower
- Term to maturity is longer
- coupon is lower


what is the quoted price

the price quoted by the media


what is the cash price

the price paid by an investor
- includes both the quoted price plus any interest that has accrued since the last coupon payment date


what is YTM an investor would earn if

the discount rate used for bond valuation
- YTM is the yield an investor would earn if
- she purchased the bond at the current market price
- she holds the bond to maturity
- she reinvests all of the coupons paid by the bond at the YTM (also gets all scheduled payments)


YTM is what

the bond's internal rate of return (IRR)
- its also the discount rate that cause the PV of the bond's future cash flow to equal its current price


what is the YTM on a 6% semi-annual coupon bond with 20 years to maturity that is selling for $1,030

(2nd) (Clrtvm) 30 (PMT) -1030 (PV) 1,000 (FV) 40 (N) (CPT) (I/y) =2.87
next 2.87 x 2 to annualize
= 5.74
- always enter the price as a negative since it is a cash outflow
- then enter the coupon and principal payments as positive numbers since these are cash inflows


what is the YTC yield to call

if the bond has a call feature
- the issuer can call (or force the investor to sell the bond back to them) before the maturity date stated in the bond indenture


callable bonds are initially protected from what

from call for a period of a few years (5,7, or 10)
- after which the issuer can call the bond


estimate the YTC on a 20 year 6% bond that is callable in 5 years at a call price of $1,050. if the bond pays semi-annual copuons and is selling for $1,030

30 PMT
-1030 PV
1050 FV
N 10
CPT I/1 = 3.081% semi - annual rate
x 2 to annualize
= 6.16% annual YTC


when the call price is above the current market price (regarding callable bonds)

unlikely to be called back by the issuer
- therefore it is selling based on its YTM not YTC


the bond would trade on its YTM if (regarding callable bonds0

it was likely the bond would be called
- occur if the bond were trading above its call price


how does the bond usually trade off for callable bonds

whichever is lower, the


what is the current yield

the ratio of the annual coupon interst dividend by the current market price
- not a true measure of the return to a bond holder
- because it disregards the bond's purchase price relative to all future cash flows and
- uses just the next year's interst payment


what is the current yield also called

the flat or cash yield


what is the formula for Current yield

CY = annual interest / B


determine the current yield for a bond with a 5.5% coupon and a current market price of $1,050

5.5/ 1050 = 5.24%
notice on last page the current yield is not equal the coupon rate of 6% or the YTM of 5.74%
- this will be true unless the bond is trading at its face value, in which case all 3 rates will be equal


if a bond trades at a premium the CY

the CY will be less than the coupon rate
- but cy grater than the YTM


if a bond trades at a discount the CY

the cy will b e greater than the coupon rate but less than the YTM


par value the coupon rate

coupon rate = cy= ytm


discount the coupon rate

is less than CY and CY than tan YTM


premium the coupon rate

is is greater than CY and CY is greater than YTM