Chapter 8 Series 7

Front 1

Leverage Financing

Back 1

Raising capital through debt since the issuer is borrowing against its net worth

Front 2

Par Value (face or principal value)

Back 2

Par value is amount issuer agrees to pay the investor when the bond matures.

Front 3

Coupon Rate

Back 3

The fixed rate of interest on a bond (in addition to par value). Interest is calculated on par value, not on price paid for the bond

Front 4

Variable Rate Bonds

Back 4

Coupon rate can be adjusted based on market conditions causing interest rates to go up or down

Front 5

What is the difference between long and short coupons?

Back 5

Long coupons occurs when the first coupon is for more than 6 months, a short coupon is for less than six months

Front 6

What is the difference between accrued interest on corporate/municipal bonds and treasuries?

Back 6

Interest accrues for corporate/munis on a 360-day year while treasuries accrue on a 365-day year

Front 7

What is accretion on zero coupon bonds?

Back 7

Since zero coupon bonds do not pay interest, accretion is adding the mathematical value of how much that bond would cost at that point for tax purposes. It may be higher or lower than the market value

Front 8

Difference between serial and term issue bonds?

Back 8

A term bond has all bonds of its offering maturing on the same date. Serial bond issues mature sequentially over several years. Serial bonds may be structured to create level debt service, so the principal and interest payment are about equal over life of offering

Front 9

What are the three types of registered bonds?

Back 9

Registered as to Principal Only, Fuly Registered, Book Entry

Front 10

What is the difference between Bearer/Registered to Principal bonds and fully registered/book entry bonds?

Back 10

Bearer/Registered to Principal bonds have a phyiscal coupon that must be turned in to receive interest, while the others receive interest via electronic payment

Front 11

Credit Risk

Back 11

A recognition that an issuer may default and not be able to pay interest/principal to its investors. The more risky the bond, the higher rate of interest

Front 12

A bond with a price of 90 is selling at what value?

Back 12

$900, or 90% of par

Front 13

A treasury note at 99.08 is selling at what?

Back 13

99.08 = 99 8/32 = 99.250 = 992.50

Front 14

What is the difference between a nominal yield and a current yield?

Back 14

The nomial yield is the coupon rate while the current yield is found by Annual Interest/Current Market Price

If a bond sold for a discount its current yield will be higher than its nominal yield

Front 15

Yield to Maturity involves what three things?

Back 15

Bond's regular interest payments, plus the difference between what the investor paid and what she receives when it matures, plus the interest received from reinvesting the interest payments

Front 16

An investor needs to purchase a bond at a what so that yield to maturity is the highest yield?

Back 16

The bond must be purchased at a discount

Front 17

Maturity

Back 17

This dictates how long it will take a bond to pay out. As interest rates change, the prices of long-term bonds tend to fluctuate more than those with shorter maturities

Front 18

What do interest rates do to coupons?

Back 18

As interest rates change, the prices of bonds with similar maturities that pay lower coupon rates tend to fluctuate more than bonds with higher coupons rates

Front 19

What is a bond's duration?

Back 19

A measurement of a bond's price sensitivity to small change in interest rates. Bonds with longer maturities tend to have longer duration

Front 20

Do short-term or long-term bonds have more sensitive yields?

Back 20

Short-term bonds do as interest rates change as those bonds are more immediately affected

Front 21

What does the normal yield curve reflect?

Back 21

Yields generally increase as maturity lengthens, so it shows lower yields in shorter maturities and higher yields in longer maturities

Front 22

When would the inverted yield curve appear?

Back 22

When interest rates are high, such as periods of high inflation, the demand for bonds with short maturities is weak so yields are driven up

Front 23

Why would an investor choose a callable bond?

Back 23

Because the issuer often puts call protection in so it must mature for a number of years before being called, and a call premium is added to the par value so the investor gets more money as a result of bond being called

Front 24

What is the difference between an in-whole and partial call?

Back 24

An in-whole call recalls an entire issue of bonds while a partial (lottery call) just means some of the bonds will be retired early. Sometimes continuous calls allow an issuer to recall bonds at any time after the first call

Front 25

Refunding

Back 25

This occurs when an issuer sells a new bond and uses the proceeds to pay off a bond that is currently outstanding. This is a benefit to issuers because it allows them the option of calling back and outstanding bond if interest rates decline

Front 26

What is the difference between prerefunding and refunding?

Back 26

If an issuer has a scheduled call date, they can prerefund that issuer by selling a refunding issue, and proceeds will then pay out the outstanding issue. The proceeds will be held in escrow and now the issuer is no longer responsible for payment of interest/principal on bonds

Front 27

Sinking Fund

Back 27

Issuers can deposit funds in this each year in order to redeem their bonds. It enhances the safety of the issue since the money will likely be there for the issuer

Front 28

Yield to Call versus Yield to Maturity

Back 28

Since we don't know when a bond will be called both of these yields must be provided to an investor. Regulations stipulate that the call-to-worst be dislcosed to a client (whichever is a worse yield). Typically if callable at par bonds selling at a discount will be quoted at yield-to-maturity, selling at premium yield-to-call, prerefunded bond at yield-to-call

Front 29

What is the difference between a put provision and a call provision?

Back 29

A call is made by the issuer, a put is when an investor can recall the bond at any time

Front 30

Difference between laddering and barbell investment strategy?

Back 30

Laddering is when you invest 1 mil, but put $100,000 down each year over 10 years. Barbell is when investors buys long and short maturities to get the high coupon on long term and the flexibility of short term

Front 31

Real Interest Rate

Back 31

The yield - the rate of inflation

Front 32

Reinvestment Risk

Back 32

Distributions of interest may come out at times of lower interest rates, meaning that your money won't accrue as much upon reinvestment