Debt Securities and Bonds Flashcards

Flashcards covering key concepts related to debt securities and bonds, including bond features, pricing, risks, and calculations.

What is the basic function of bonds?

Investors lend money to issuers (corporations, governments, municipalities).

What is the status of Bondholders?

Creditors with a higher claim than shareholders in bankruptcy.

How do bonds typically pay?

They pay regular income (interest) and are called fixed-income securities.

What are Bearer Bonds?

Physical certificates with attached coupons and no record of ownership.

What are Registered Bonds?

Owner’s name is recorded with the issuer or transfer agent and interest is automatically paid to the registered owner.

What are Book-Entry Bonds?

No physical certificate; ownership is recorded electronically by a central depository.

What is a Depository?

A company that safely holds financial securities and keeps track of ownership electronically.

What does Book-entry mean?

Recorded by a depository.

What is Par Value?

The amount the investor gets at maturity, usually $1,000 per bond.

For bonds with par value of $1,000, how do you convert the quote to a price?

Multiply by 10.

How are bonds quoted?

A percentage of par value

What is Yield to Maturity (YTM)?

Annualized return based on current price, coupon, and time left.

What are the fractions in bond quotes?

Corporate, muni bonds & agency: in 1/8ths, Government bonds: in 1/32nds.

What is a Coupon?

Interest paid to bondholders, expressed as a percentage of par value.

What are Fixed-rate bonds?

Coupon stays the same to maturity.

What are Floating-rate bonds?

Coupon changes based on a benchmark (e.g., T-bill rate).

What are Zero-Coupon Bonds?

Pay no interest during their life; investors buy them at a discount and receive full par value at maturity.

How are Zero-Coupon Bonds taxed?

Taxed annually on imputed/phantom interest, even if no money is received yet.

What is the inverse relationship between interest rates and bond prices?

Interest rates and bond prices move in opposite directions.

When is a bond trading at a premium?

Market value is greater than par.

When is a bond trading at a discount?

Market value is below par value.

What is a basis point (bp)?

0. 01%

What is the Maturity Date?

When bond principal is repaid to investor.

What are Longer-term bonds?

Pay higher interest and are more sensitive to interest rate changes.

How does a bond's price move toward par as it reaches maturity?

A 10-year bond trading at a discount for 93 ($930) will move toward par ($1,000) as it approaches maturity. A premium bond purchased for 109 ($1,090) will decline toward par as it approaches maturity.

What is a Sinking Fund?

Money set aside to help repay bonds at maturity; issuers deposit funds into an escrow account.

What is a Callable Bond?

A bond the issuer can redeem before maturity, usually when market interest rates fall.

What does a Bondholder receive when their bond is called ?

Receives par, final interest, and possibly a call premium.

What is Call Protection?

Period when the bond can’t be called, protecting investors from early calls.

Who does a call feature benefit?

The issuer, not the investor.

What is a Puttable Bond?

Gives the investor the right to sell the bond back to the issuer early if certain conditions occur.

What is a bond's yield?

The investor’s return on a bond.

What is Nominal Yield (NY)?

The coupon rate stated on the bond; fixed for the life of the bond.

What is the formula for Current Yield (CY)?

Annual Interest / Market Price

What is Yield to Maturity (YTM)?

Total return if held to maturity, including annual interest and any gain/loss if bought at a discount/premium.

What is Yield to Call (YTC)?

Calculates return if bond is called on the first possible call date, factoring in time until first call, call price, and any call premium.

What is the key relationship between YTC and YTM?

Premium bond → YTC < YTM, Discount bond → YTC > YTM

What is Interest Rate Risk?

Bond prices will change when interest rates change.

Which bonds are more sensitive to rate changes?

Long-term bonds and low-coupon bonds (including zero-coupon bonds).

What is Call Risk?

Issuer redeems (calls) the bond early when interest rates fall.

What is Reinvestment Rate Risk?

After a bond is called (or matures), the reinvested funds will earn a lower return.

What is Inflationary Risk (Purchasing Power Risk)?

Inflation erodes the real value of fixed payments (like bond interest).

What is Credit Risk (Default Risk)?

The issuer won’t make interest or principal payments.

What is the credit risk of U.S. Government bonds?

Low credit risk but still exposed to interest rate and inflation risk.

What are Credit Ratings?

Agencies publish these to show a bond’s default risk level.

What are Investment-grade bonds?

Lower default risk and lower yield.

What are Non-investment-grade bonds (junk bonds)?

Higher default risk and higher yield.

What is EMMA (Electronic Municipal Market Access)?

A public online resource run by the MSRB to research and track municipal bonds.

What is the purpose of EMMA?

Investors research and track municipal bonds, including bond issuers, descriptions, credit ratings, prices, and interest rates.

What is Accrued Interest?

Interest earned by the seller since the last payment, up to (but not including) the settlement date.

How is accrued interest taxed?

Added to the bond's purchase price and taxed as ordinary income to the recipient.

What is the Dated Date?

Day a new bond starts earning interest.

How is accrued interest calculated for different types of bonds?

Corporate, municipal, and agency bonds: Assume 360-day year with 30-day months. Treasury notes and bonds: Use 365-day year with actual days.

What bonds trade flat?

Bonds in default or zero-coupon bonds.

What is Cost Basis?

The bond’s tax value, used to determine gain/loss when sold.

What is Accretion?

Bond bought below par → cost basis is increased each year toward par.

What is Amortization?

Bond bought above par → cost basis is decreased each year toward par.

What happens to the cost basis at maturity?

At maturity, the cost basis always becomes par ($1,000).