Managerial Finance Exam Ch 6,7,8

Companies and governments issue BLANK to the investing public when they need to raise money which may be more than can obtain from a bank

Bond securities (Bonds)

BLANK and BLANK issue bond securities (bonds) to the investing public when they need to raise money which may be more than can obtain from a bank

Companies and governments

What happens after bonds are issued

They are traded OTC (over the counter) or on exchanges such as the New York or Chicago Bond Exchange and are called “outstanding bond or seasoned issue”

Why is the ability to sell a bond an advantage to investors

Because it provides them with liquidity

Who issues treasury bonds

US Government

Who issues corporate bonds

Corporations

What is used to determine how risky a corporate bond is

Rating agencies

True or false:
Some companies have more/less default risk than others

True

Who issues municipal bonds

State and local governments

Who issues foreign bonds

Foreign government or corporation

Why would a municipality issue a bond

To finance public projects like roads, schools, or water systems, and to refinance existing debt

Bonds

Long-term contract

Bond indenture

Legal document that outlines all the terms

BLANK are Liabilities/Debt to the issuer/borrower on their balance sheet

Bonds

Bonds are BLANK to the issuer/borrower on their balance sheet

Liabilities/Debt

Bonds are Liabilities/Debt to the BLANK on their balance sheet

Issuer/borrower

Bonds are Liabilities/Debt to the issuer/borrower on their BLANK

Balance sheet

BLANK are Assets called “debt securities”, to the bondholders/purchaser

Bonds

Bonds are BLANK called “debt securities”, to the bondholders/purchaser

Assets

Bonds are Assets called BLANK, to the bondholders/purchaser

“Debt securities”

Bonds are Assets called “debt securities”, to the BLANK

Bondholders/purchaser

A BLANK usually requires the payment of interest over its life with repayment of principal on the maturity date.

Bond

A bond usually requires the payment of BLANK over its life with repayment of principal on the maturity date.

Interest

A bond usually requires the payment of interest over its life with repayment of BLANK on the maturity date.

Principal

A bond usually requires the payment of interest over its life with repayment of principal on the BLANK.

Maturity date

Bond Principal aka Face Value/Par value/Maturity Value

1. Amount must pay to bondholders at the maturity date

2. The amount used to compute the bond’s periodic cash interest payments.

3. All bonds have a face value. The face value is usually $1,000, but it can be any amount.

All bonds have a BLANK. It’s usually $1000, but it can be any amount

Face value

The bond principal is the amount used to compute the bond’s BLANK

Periodic cash interest payments

Bond principal is the amount that must be paid to BLANK at the BLANK

Bondholders at the maturity date

Principal (face, par, or maturity value)

Amount paid at maturity date

Coupon rate (stated, contract, or nominal rate)

Rate used to compute cash interest payments

Calculate interest/coupon payment if there's a $1000 bond due in 5 years with 10% interest paid semiannually

1000 x 0.10 x 6/12 = $50

Types of coupon interest rates

• Fixed-rate bonds

• Floating rate bonds

• Zero coupon bonds

• Original issue discount bond

Fixed-rate bonds

Most common

Floating Rate bonds

Coupon rate set for initial period (maybe 6 months) then re-sets every 6 months based upon some open market rate (ex: 10 year treasury rate + 1.5%)

Zero coupon bonds

Don’t pay interest, but price is below par

Original Issue Discount Bond

Issued at price significantly below par

Maturity date

The date on which the par value must be repaid

Call provisions

Give the issuer the right to redeem the bonds prior to the normal maturity date

Call provisions give the BLANK the right to redeem the bonds prior to the normal maturity date

Issuer

Call provisions give the issuer the right to BLANK the bonds prior to the normal maturity date

Redeem

Call provisions give the issuer the right to redeem the bonds BLANK (When)

Prior to the normal maturity date

Call Premium

Amount issuer pays over par value when calling the bond

Deferred calls

Bonds are not callable until several years after issue, generally 5-10- provides call protection

Most bonds

Deferred calls with premium that declines as bond approaches maturity

When would a company want to call a bond?

When current market interest rates fall below the bond's original interest rate, allowing them to refinance at a lower cost

Sinking Fund Provision

Requires the issuer to buy back a specified percentage of the issue each year

What is considered safer than bonds without sinking funds

Sinking Fund Provision

Issuer will choose method that costs the BLANK

Convertible bond

Bondholder given option to exchange bond for stock

Warrant

Issued with a bondholder option to buy a stated number of shares of common stock at a specified price

Putable bond

• Allows holder to sell the bond back to the company prior to maturity.

• May want to if can get higher rates on new bond

Putable bonds allow BLANK to the company prior to maturity

Holder to sell the bond back

Income bond

Pays interest only when firm earns enough income to pay interest

Indexed bond

Coupon rate not fixed (moves with inflation)

Default

If issuer does not pay principal or interest when due

Bonds are primarily traded in the BLANK more than exchanges

over-the-counter (OTC) market

OTC Market

Decentralized, dealer-to-dealer network rather than on a centralized exchange

Most bonds are owned by and traded among BLANK

Large financial institutions

Value of any financial assets = ?

PV of Cash flows expected to produce, discounted at the market rate

INT

Coupon payment

r_d

Market interest rate

N

Years to maturity

M

Par value (face value)

Selling Price/Intrinsic Value = ?

Present Value of Principal + PV of Interest