Chapter 7 Lecture Notes Flashcards
(56 cards)
What is a bond?
A government debt instrument
Treasury Bonds
Issued by federal government, no default or liquidity risk, do have maturity risk (i.e. interest rate risk)-> fluctuation
Corporate Bonds
Issued by corporations, have default risk, liquidity risk, and maturity risk
Municipal Bonds (Munis)
Issued by local state and local governments, have default risk and liquidity risk, most are exempt from federal taxes so carry lower interest rates
Foreign Bonds
Issued by foreign governments or corporations, have default risk, liquidity risk, maturity risk and exchange rate risk
Par Value
Stated face value of the bond; any multiple of $1,000
Coupon Interest Rate
Designates coupon rate
Interest = Coupon Rate * Par
Floating Rate Bond
Interest rate is tied to some rate such as the Treasury bond rate
Zero Coupon Bonds
Pay no coupon payments; offered at substantial discount so have capital appreciation rather than interest income
Maturity
Any maturity is allowed; most range from 10 to 40 years
Call Provision
Most corporate bonds have the right to call the bonds for redemption by paying the par value plus a call premium (penatly) - typically equal to one year’s interest if called in the first year, then declines by INT/N each year thereafter; may have deferred call (call protection)
Sinking Fund Provision
Facilitates orderly retirement of the bonds; handled two ways: (1) certain percentage of randomly chosen bonds retired each year, (2) certain amount bought on the open market
If interest rates have risen, causing bond prices to fall, the firm will ____ bonds in the open market at a ______
buy
discount
If interest rates have fallen, it will ____ the bonds
Call
Convertible Bonds
Convertible into shares of common stock, at a fixed price, at the option of the bondholder; lower coupon rate
Bonds with Warrants
Similar to convertibles; long-term options which permit the bondholder to buy stock for a stated price; lower coupon rate
Putable Bonds
Allows investors to sell bonds back to company
Income Bond
Pays interest only if the interest is earned
Indexed (purchasing power) Bond
Interest paid rises automatically when inflation increases (ex: the US Treasury began issuing indexed bonds in January 1997 at 3.45% plus inflation)
TIPS
Treasury Inflation Protected Securities
What is the value of any asset?
The present value of its cash flows, using the appropriate required rate of return
Kd
Required rate of return of the bondholder
How is Kd set?
By the going rate of return of debt of this type at the time
The discount rate is affected by:
- The riskiness of the cash flows (default risk, maturity risk, and liquidity risk)
- The level of interest rates in the current economy
