Term
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Definition
| 1.Contract b/w issuer and investor
--Investor lends money to issuer and thus, becomes a creditor. Issuer, who can be the gov't or a private business, promises to pay the money back when it matures along with interest (coupon rate). |
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Term
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Definition
| 1.Bearer-Does not have the name of the owner recorded either on the bond or on the books of the issuer. The bond has interest coupons attached. When payment is due, holder clips off the appropriate coupon and deposits it in a bank. NO LONGER ISSUED IN U.S. |
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Term
| Bonds Terms
Registered Bonds |
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Definition
| 1.Registered as to principal only will have the owner's name/address. Payments are received by means of attached interest coupons
2.Fully Registered-Payments are received by means of a check from the issuer every six months
3.Book entry form-Becoming quite common. No phyiscal bond issued. Done by computer. All negotiable U.S. Treasury/gov't agency debt is issued in book entry form. |
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Term
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Definition
| Amount that the issuer agrees to pay the investor when the bond matures. Also called, principal or face amount.
Typically issued with $1000 par. Many munis are $5000. Round lot of bonds would be $100000 of total par value. |
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Term
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Definition
| 1.When selling less than par=discount. When selling more than par=premium.
2.Price of bond usually stated as a % of its par value. Bond price=90, selling at a discount for $900.
3.1% increment=point. Dollar value of a bond point is $10. |
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Term
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Definition
| 1.Day on which issuer pays the face amount. Investor will receive last semiannual interest payment.
2.Can be short-term or 100 years. Longer maturity pays higher interest. Market prices of long-term tend to be more volatile. |
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Term
| Bonds
Maturity Date
Serial issues vs. Term Issues |
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Definition
| 1.Serial Bond Issue-bonds mature sequentially. Allows issuer to pay principal over time.
2.Term Bond Issue-All bonds mature at the same time. Called dolland bonds as they are qouted at a dollar price in secondary market.
3.Balloon issue-Portion of issue mature serially with a large portion of them maturing in one specific year. |
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Term
| Bonds
Coupon Rate, Zero Coupon Bonds |
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Definition
| 1.The stated amount of interest is called the interest rate.
2.Zero Coupon-Bonds that do not pay interest at regular intervals. Instead, the bonds are bought a very large discount. At maturity, principal paid in full. Used for investors who want a lump sum of cash in so many years. |
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Term
| Calculating Returns on Fixed-Income Securities
Nominal Yield |
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Definition
| Stated rate of interest. FIXED AND WILL NO CHANGE. 10% coupon pays $100 per year. |
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Term
| Calculating Returns on Fixed-Income Securities
Current Yield |
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Definition
| Bond's market price may fluctuate. Current yield measures the interest the investor receives from the bond compared to its current market price.
Current Yield= Annual Interest Payment/Current Market Price
Does not take into consideration the price appreciation on a discount bond or price depreciation on a premium bond. |
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Term
| Calculating Returns on Fixed-Income Securities
Yield to Maturity |
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Definition
| Measures investor's total overall return. Most widely quoted type of yield for bonds. |
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Term
| Calculating Returns on Fixed-Income Securities
Yield to Call |
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Definition
| Takes into acount a bond's cash flow through its first call date.
Calculated the same way as YTM, except that it reflects the bond's interest payments until it is called, rather than when it matures. |
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Term
| Prices and Yields
An inverse relationship |
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Definition
| As interest rates RISE, the price of existing bond DECLINE since the demand for existing bonds that now offer lower interest rates will decline, driving down their prices.
If interest rates DECLINE, the price of existing bonds will INCREASE since they are worth more than a new bond with a lower coupon |
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Term
| Prices and Yields
Interest-Rate Risk |
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Definition
| Definition:When one purchases a bond, he or shes runds the risk that the market value of their investments may decline if interest rates rise.
Bonds with londer maturities are more vulnerable to interest rate risk. Also, bonds with lower coupon rates rend to be more sensitive to interest rate risk. |
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Term
| Price Changes and Resulting Yield Changes
PAR BOND |
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Definition
| -10% bond was purchased at 100
-Nominal Yield is coupon
-Current yield= $100/$1000=10%
Since the bond was purchased at par and will be redeemed at pat at maturity, the YTM will also be 10% |
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Term
| Price Changes and Resulting Yield Changes
Discount Bond |
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Definition
| -If interest rates increase, 10% existing bond price goes down to make it more competitive.Assume purchase price is 900
-Nominal yield=10%
-Current yield=$100/$900=11.11%
-If held to maturity, the bond will pay $1000, which is $100 more than its purchase price. Additional $100 in appreciation adds to overall return. Thus, YTM will be more than current yield. |
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Term
| Price Changes and Resulting Yield Changes
Discount Bond Picture |
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Definition
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Term
| Price Changes and Resulting Yield Changes
Premium Bond |
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Definition
| -If interest rates increase, 10% existing bond price goes up because it has a more attractive yield than the market.Assume purchase price is 110.
-Nominal Yield=10%
-Current Yield=100/110=9.1%
-If held to maturity, the bond will pay $1000, which is $100 less than its purchase price.Thus, YTM will be less than current yield in order to reflect the premium paid for bond. |
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Term
| Price Changes and Resulting Yield Changes
Premium Bond Picture |
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Definition
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Term
| Price Changes and Resulting Yield Changes
Summary of Yield Relationships |
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Definition
| PAR-NY = CY = YTM
DISCOUNT-NY < CY < YTM
PREMIUM-NY > CY > YTM |
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Term
| Relationship b/w Prices, Yields, and Maturity Dates |
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Definition
| 1.Bonds with longer maturities have higher coupons. $$ is tied up for longer, and thus the investor expects more return.
2.Prices of long-term bonds tend to fluctuate more than those with shorter maturities.
3.Lower coupon bonds are more sensitive to changes in interest rates.
4.Yields of short-term bonds will fluctuate more than long-term bonds. |
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Term
| Yield Curves
Normal Yield Curve |
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Definition
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Term
| Yield Curves
Inverted Yield Curve |
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Definition
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Term
| Yield Curves
Flat Yield Curve |
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Definition
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Term
| Yield Curves
Real Interest Rate |
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Definition
| -Rate investor in fixed-income securities actually receives once inflation is taken into account.
Yield-Inflation=Real Interest Rate
Purchasing Power Risk-Money you invest today won't be worth as much when you get it back in the future.
Reinvestment Risk-Potential that future distributions of interest/principal may have to be invested at a lower rate of return. |
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Term
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Definition
| Corps with poor credit ratings must pay a higher rate of interest.
Gov't securities have no risk b/c of full faith and credit.
Moody's and S&P rate bonds
AAA-BBB (Aaa-Baa) are considered investment grade while BB (Ba) and below are high-yield or junk bonds. |
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Term
| Bonds
Redeeming Bonds (1) |
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Definition
| Some bonds have call options that allow the issuer to call back the bonds before they mature. This is called a call provision.
Refunding is when the issuer calls back the bonds and then refinances them at a lower interest rate. |
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Term
| Bonds
Redeeming Bonds (2) |
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Definition
| Call Risk-Investor is unlikely able to reinvest their money for the same return that they were previously receiving before the call back.
Call Premium-Issuer buys back bonds at more than par to compensate for call risk.
Continous Call-Call feature that can be exercised at any time after the first call |
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Term
| Bonds
Redeeming Bonds (3) |
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Definition
| Issuers lock in a lower rate prior to a scheduled call date. Proceeds from refunding issue invested in gov't securities and deposited in bank.
Elimination of responsibility on the part of the issuer and the elimination of the bondholder's rights is referred to as defeansance. |
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Term
| Bonds
Redeeming Bonds (4) |
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Definition
| Sinking Fund-Money is deposited in order to redeem bonds. Ensures that the debt will be paid in an orderly fashion AND enhances the safety.liquidity of the issue. |
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Term
| Bonds
Redeeming Bonds (5) |
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Definition
| Put Provisions-Opposite of a call provision. Gives the bondholder the right to redeem the bond on a specified date prior to maturity.
Yield on bonds with a call feature will be higher than the same bond without one to make it more attractive to investors. Yields will generally be lower for bonds with a put feature. |
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Term
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Definition
| When a corp wants to raise capital but not issue equity, they will issue bonds. Bondholder is a creditor, not an owner.
Corp must pay the interest on the bonds before paying dividends.
If company is liquidated, bondholders receive their investment first |
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Term
| Trust Indenture Act of 1939 |
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Definition
| New issues of CORPORATE bonds are subject to the TIA of 1939. (not munis, gov't, etc)
If the issue is more than $10 million, corp must provide an indenture (agreement) b/w issuer and trustee. Trustee is usually a bank or trust company that must act in the bondholder's interest. |
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Term
| THE INDENTURE (Two Types)
1.Closed End Indenture
2.Open End Indenture |
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Definition
| 1.Does not permit the corp to issue additional bonds secured by the same assets as the original issue. This provides investor with most protection against default.
2.Open-End Indenture-May issue additional bonds secured by the same assets as the original issue. Indenture will usually require the corp meet a specific level of earnings before it can issue more. This requirement known as: EARNINGS TEST or ADDITIONAL BONDS TEST |
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Term
| Types of Bonds (Two types)
Secured |
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Definition
| 1.Secured are backed by the full faith and credit of the issuer and by the specific assets that the corp owns:
a.Mortgage Bonds-Gives bondholders lien of property.
b.Equip. Trust Certificates-Secured by piece of equip company owns.
c.Collateral Trust-Secured by third-party securities owned by the issuer. |
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Term
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Definition
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Term
| Types of Bonds (Two types)
Unsecured |
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Definition
1.Most corp bonds are secured only by the corp's good faith and credit. These are calles notes and debentures. If issuer defaults, holders of securities have same claim on the company's assets as any other creditor, before stockholders, but after secured bondholders.
2.Subordinate Debentures-An issue that has a junior claim on company's assets. |
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Term
| SUMMARY OF LIQUIDATION RIGHTS |
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Definition
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Term
| Corporate Bonds
Convertible Bonds |
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Definition
| Allow investor to convert the bond into chares of the company's stock at a predetermined ratio.
To determine the amt of shares, divide par value by the conversion price. This is the conversion ratio. |
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Term
| Corporate Bonds
Convertible Bonds
Example |
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Definition
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Term
| Corporate Bonds
Convertible Bonds
Conversion Value |
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Definition
| Market Value of Stock x Number of Shares Received
If Coversion Value is less than par, the investor will unlikely convert
If conversion Value is more than par, the investor would benefit from conversion. |
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Term
| Corporate Bonds
Convertible Bonds
Parity |
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Definition
| When the convertible bond's value is equal to it's market value. Most bonds trade at a premium to parity.
For example, if the conversion value of a bond is $750 ($30 x $25) and its market price is $900, then the conversion premium is $150. The bond is selling at a 20% premium to parity. ($150/$750) |
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Term
| Corporate Bonds
Convertible Bonds
Advantages and Disadvantages |
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Definition
| Advantage:Give investors a greater amt of samefty than preferred/common stock.
Advantage:Give potential for capital appreciation if the underlying stock appreciates in value.
Disadvantage:If a lot of bonds are converted into stock, price of stock would be dilluted, and EPS would decrease. |
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Term
| Corporate Bonds
Convertible Bonds
Forced Conversion |
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Definition
| Another disadvantage:Happens when the redemption price of the bonds may be less than the version value. Bondholder could be forced to either convert the bonds immediately or accept less than their conversion value. |
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Term
| Corporate Bonds
Convertible Bonds
Conversion Value Example |
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Definition
| Conversion Price of $40. Stock Currently at $50. Corp calls the bond at 105 ($1,050).
Step 1:Conversion Ratio=$1000/40=25 shares
Step 2:Conversion Value=$50 x 25 shares=$1,250
Therefore, conversion should be done as the Conversion Value>Call Value |
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Term
| Corporate Bonds
Convertible Bonds
Arbitrage |
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Definition
| Technique that involves profiting from price differentials in the same or similar security. |
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Term
| Corporate Bonds
Other Types
Income and Eurodollar |
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Definition
| 1.Income-Issued by companies in reorganization (bankruptcy). Promises to pay interest only is it has sufficient funds. Trade at a deep discount. Considered speculative. Also called adjustment bonds and would not be good for FSG
Eurodollar-dollar-denominated deposit outside the U.S. Pay principal/interest in USD and are issued outside of U.S. (World Bank) |
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Term
| Corporate Bonds
Secondary Market Trading |
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Definition
| Quotes-Corp. bonds are quoted at a dollar price, in points and eighths of a point.
Example--Price= 93 and 5/8
Price=$93.625 |
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