Bond Valuation and Analysis

Comprehensive practice flashcards covering Bond Valuation and Analysis lecture notes, including types of bonds, risk factors, key characteristics, and mathematical valuation metrics.

Bond

A fixed-income financial instrument that represents a loan made by an investor to a borrower, typically corporate or governmental.

Bond Valuation

The process of determining the present value of a bond's future interest payments and its maturity value.

Bond Analysis

The process of evaluating a bond's characteristics, risks, and potential returns to determine its suitability as an investment through examination of creditworthiness and market conditions.

Bond Agreement

A contractual agreement between the issuer and the bondholders.

Corporate Bonds

Bonds issued by companies to raise capital, typically offering higher yields and higher risk than government bonds.

Government Bonds

Bonds issued by national governments, considered low-risk, such as U.S. Treasury bonds.

Municipal Bonds

Bonds issued by states, cities, or other local government entities that often offer tax-free interest payments.

Zero-Coupon Bonds

Bonds that do not make periodic interest payments but are issued at a discount to their face value and pay the full face value at maturity.

Convertible Bonds

A type of hybrid security that can be converted into a specified number of shares of the issuing company’s stock.

Interest Rate Risk

The risk that the price of existing bonds will fall when interest rates rise.

Credit Risk (Default Risk)

The risk arising when a borrower is unable to make regular annual interest payments and the principal at maturity.

Inflation Risk

The risk that inflation will erode the purchasing power of the bond’s interest payments and principal repayment.

Liquidity Risk

The risk that it may be difficult to sell a bond at its fair market value before maturity.

Face Value (Par Value)

The principal amount that the issuer agrees to repay the bondholders on the maturity date, also known as nominal value or redemption value; typically is $1,000$.

Coupon Rate

The interest rate paid to bondholders, usually expressed as a percentage of the face value.

Coupon Payments

The periodic interest payments made to bondholders, usually semi-annually or annually.

Maturity Date

The date on which the face value of the bond is repaid to the bondholder and the issuer's obligation ends.

Yield

The rate of return expected by bondholders from their investment, including interest payments and price differences.

Current Yield

The ratio of coupon payment to the market price of a bond, calculated as: $\frac{\text{Coupon}}{\text{Market price}} \times 100$.

Yield to Maturity (YTM)

Also known as gross redemption yield or internal rate of return, it is the market interest rate required on a bond assuming it is held to maturity and all payments are made.

Yield Curve

A line that plots interest rates of bonds having equal credit quality but differing maturity dates.

Normal Yield Curve

An upward sloping yield curve.

Inverted Yield Curve

A downward sloping yield curve.

Value of a Bond

The present value of the expected future cash flows (interest and principal repayment) discounted at the required rate of return or cost of the bond.

Credit Spread

The difference between the actual cost of borrowing and the risk-free rate of return on bonds, acting as compensation to investors for credit risk.

Basis Point

A unit of measurement for interest rates and credit spreads where $1$ basis point equals $0.01\%$, used to state the credit spread.

Concept of Bond Duration

A measure of the sensitivity of the bond's full price to changes in interest rates, indicating how long an investor must wait to recoup their investment.

Macaulay Duration

The weighted average time until all the bond's cash flows are paid, used to evaluate bonds independent of their term to maturity.

Modified Duration

A measure of the percentage change in the price of a bond given a change in its yield to maturity, indicating price sensitivity to interest rate changes.

Conversion Ratio

A feature of convertible bonds that specifies the number of shares of stock each bond can be converted into.

Conversion Price

The price at which a convertible bond can be converted into stock, usually set at a premium to the stock’s market price at issuance.

Equity Dilution

A risk of convertible bonds where the value of existing shares is diluted due to an increase in outstanding shares when bondholders convert to stock.