Chapter 7: Bonds

These flashcards cover key concepts related to bonds, their structure, pricing, risks, and different types of bonds.

What is a Bond?

A form of long term debt (LTD) where a firm issues bonds to raise capital and pays bondholders back over time.

Face Value

The amount a bond is worth at maturity; typically set at 1,000.

Maturity

The date when the company will pay back the investors in full.

Coupon Payments

Periodic payments made to bondholders, calculated as a percentage of the bond's face value.

Premium Bond

A bond selling for more than its face value.

Discount Bond

A bond selling for less than its face value.

Yield to Maturity

The return earned on a bond from now until maturity, which can change if market rates change.

Government Bonds

Bonds issued by the government, considered a 'risk-free' investment; includes T-Bills, T-Notes, and T-Bonds.

Investment Grade

A category of bonds rated as low risk and typically paying lower interest rates.

Speculative Grade

A category of bonds rated as higher risk, generally paying higher interest rates to compensate for risk.

Zero-coupon Bonds

Bonds that do not pay a coupon and always sell at a discount.

Call Provision

The right of a firm to call back the bond early, usually paying investors a premium compared to the face value.

Putable Bonds

Bonds that give the investor the right to force the company to repurchase the bond.

Convertible Bond

A bond that can be converted into stock of the same company.

Income Bond

A bond that only makes coupon payments if the company has enough income.

Price Risk

The risk that the value of a bond will decline if interest rates rise.

Reinvestment Risk

The risk of needing to reinvest at a worse interest rate if interest rates fall.

Default Risk

The chance that a firm will not make payments to bondholders.

What is the general structure of bond payments?

Bonds involve the issuer (borrower) paying regular coupon payments to bondholders (lenders) until a specified maturity date, at which point the issuer repays the bond's face value.

What is a seasoned bond?

A bond that has been outstanding in the market for some time, distinguishing it from a newly issued bond.

What is the relationship between interest rates and bond prices?

Bond prices move inversely to interest rates. When interest rates rise, existing bond prices fall, and vice versa.

Under what conditions might a firm exercise a call provision on a bond?

A firm is likely to call a bond when prevailing market interest rates have fallen significantly below the bond's coupon rate, allowing the firm to refinance at a lower cost. This typically occurs when the bond's Yield to Call (YTC) is less than its Yield to Maturity (YTM).

What is Yield to Call (YTC)?

The total return an investor can expect to receive if a callable bond is bought at the current market price and held until the call date.

What is Current Yield?

The annual coupon payment divided by the bond's current market price. It represents the annual income return from the bond.

How do calculations for a bond change if payments are semiannual instead of annual?

1. Coupon Payments: Divide the annual coupon payment by 2. 2. Number of Periods (N): Multiply the number of years to maturity by 2. 3. Yield Rate: Divide the annual yield (e.g., YTM) by 2 to get the semiannual yield.