Chapter 5: Fundamentals Of Debt

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Bearer Bonds (no-longer issued in the U.S.)

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i. Does not have the name of the owner recorded either on the bond or on the books of the issuer
ii. When an interest payment is due, the bond-holder clips off the appropriate coupon and deposits it in a bank.

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Registered Bonds

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Has holder’s name and address recorded on the bond and on the books of the issuer.

The bond may be registered as to principal only or fully registered

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Term bond issue

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: all the bonds mature at the same time. They are also referred to as dollar bonds, because in the secondary market they are quoted at dollar price (percentage of par) rather on a yield-to-maturity basis.

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Balloon issue

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a portion of the issue matures serially and a large portion mature in one specific year.

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Nominal Yield

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The stated rate of interest that the issuer promises to pay the bondholder. This rate is fixed at issuance and will not change.

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Current Yield

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i. The interest that the investor receives from the bond compared to its current market price.
ii. Formula: Current Yield = Annual Interest Payment / Current Market Price
iii. An issue with Current Yield is that it fails to account for price appreciation on a discount bond or the price depreciation on a premium bond.

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Yield to Maturity

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i. It includes the yearly interest that the investor receives, as well as the difference between what the investor paid for the bond and the amount received at maturity.
ii. Requires a financial calculator
iii. Also referred to as the yield or basis
1. One basis point = 1/100 of 1% (e.g. .25% = 25 bp)

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Yield to Call

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i. Takes into account a bond’s cash flow through its first call date.
ii. Calculated the same way as YTM, except it only takes into account the interest payments till it is called.

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Discount Bonds

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Nominal yield < Current Yield < YTM

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Premium Bonds

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Nominal yield > Current Yield > YTM

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Prerefunding (advanced refunding)

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i. A bond issuance used to pay off another outstanding bond. The new bond will often be issued at a lower rate than the older outstanding bond.
ii. A bond issuance in which new bonds are sold at a lower rate than outstanding ones. The proceeds are then invested, and when the older bonds become callable they are paid off with the invested proceeds.
iii. Advance refunding is most often used by governments seeking to postpone their debt payments to the future instead of having to pay off a large amount of debt in the present.

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Defeasance (defease)

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A provision that voids a bond or loan when the borrower sets aside cash or bonds sufficient enough to service the borrower's debt.