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82 Cards in this Set
- Front
- Back
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DEBT
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bank loans or bonds (contractual obligation)
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What is Equity
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Stocks or other ownerships stake (exchange money for ownership)
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Which is cheaper; Debt or Equity?
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Debt
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True or false: Dividends on stock are fully taxable
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True
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What is the difference between unpaid debt and unpaid equity
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Unpaid debt is a liability and can force the firm into bankruptcy; unpaid equity can not force a firm into bankruptcy
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How is equity paid out?
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Dividends
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What is a bond and what are the two parties involved?
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Long-term agreement (more than 1 yr), between govt/corportation and another party, BORROW MONEY AND AGREE TO PAY IT BACK ON SPECIFIED TERMS. Two parties: One issues and one purchases
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What is par value
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The face value of the bond. Principal amount to be repaid at end of loan.
Give 1,000 in the beginning, give back 1,000 in the end |
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What is coupon rate and an example of a coupon rate?
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Bond's interest payments per dollar of par value. It's like interest rate, and it's a reflection of the risk level of the investment. If par value is $1,000 and the coupon is $100, then the coupon rate is 10% (1,000/100)
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What is the coupon payment?
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Regular interest payments made on a bond. (If par value is $1,000 and the coupon rate is 10%, the coupon payment is $100. $1,000*.10=100
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True or false; Bonds have the same maturities
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FALSE; Bonds have different maturities
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What is maturity?
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The date on which the principal amount of the bond will be paid
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What is the Yield to Maturity? (YTM)
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Current interest rate required in the market on a bond. It's basically the market rate; what the market is willing to pay
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What are the two parts of a bond?
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Coupon Payments (annuity)
Principal Payments (present value) |
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What is the correct way of writing out: THE VALUE OF A BOND IS EQUAL TO THE PV OF THE COUPON PAYMENT + PV OF THE PRINCIPAL AMOUNT
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C*PVIFA(r,t) + Par*PVIF(r,t)
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A coupon rate is
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COMPENSATION and it's like interest rate
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If a market rate is 5% and a corporation offers 4%, will the investor invest in the bonds?
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NO
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What is a discount bond?
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When the coupon rate is less than the market rate or YTM, it is a discount bond
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What is a par bond?
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When the coupon rate equals the YTM
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What is a premium bond?
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When the coupon rate is greater than the YTM, it is a premium bond
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What is a discount bond?
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Bond that sells for less than its face value
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What is a premium bond
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Bonds that sells for more than its face value
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If the Market Rate (YTM) is 8% and the Coupon Rate is 10%; which one do I chose?
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10% coupon rate
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True or False; You should never put all of your money in one place
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True
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True or false; coupon rate being high means that there is a lot of risk
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True
A 5% investment is safer than a 20% coupon rate investment |
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How do you solve this question:
Zero coupon bond matures in 7 years and you want to earn 3% |
1000/1.03^7 = $813.09
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True or false
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Bond prices and interest rates always move in the same direction
FALSE: Bond prices and interest rates ALWAYS move in opposite directions YTM GOES UP; PRICE OF BOND GOES DOWN |
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Bonds are issued by 3 groups:
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1.Federal Govt (Treasury)
2.State/Local (Municipal Bonds) 3.Corporate Bonds |
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True or false; U.S. Treasuries are the biggest borrowers
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TRUE
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What are T-Bills
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bonds with maturity of less than 1 year
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What are T-Notes?
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Maturities of 1-10 years
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What are T-Bonds
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Maturities of 10+ years
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True or false; Coupons are exempt from State Income Taxes
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TRUE
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Which bonds have no risk of default and are the only ones that can make this claim? They have a lower coupon rate and are often sold at a discount with no coupon payment?
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Treasury Bonds
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What are municipal bonds?
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Bonds issued by state and local governments; there is a chance of default
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What are municipal bonds issued to pay for?
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Issued to pay for things like streets, parks, etc
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What are corporate bonds?
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Bonds issued by corporations to raise capital
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Which bonds have varying degrees of default risk?
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Corporate/Municipal
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Why are corporate bonds issued?
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To better the company
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If you are looking at two bonds of the same quality (rating) and one is a corporate bond with a coupon of 6.8% and a muni with a coupon of 5%, which should I chose, assuming a 30% tax bracket?
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MUNI of 5%
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What time of bond pays no coupons?
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Zero Coupon Bonds
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What is a good example of a zero coupon bond?
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Treasury Bonds
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What is a floating rate bond?
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Bond where the coupon rates are adjustable; the coupon floats-- so it is less likely to differ substantially from the yield-to-maturity
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Is there a less price risk with floating rate bonds?
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Yes
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What is a collar?
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A collar is when the rate cannot go above a specified ceiling or below a specified floor
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What type of bond is an adjustable rate mortgage?
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Floating Rate Bonds; these are getting people in trouble with the mortgage crisis; you get locked in for 3 years and after that the rate adjusts; good if you only plan on living in your house for 3-5 years
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What are income bonds?
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Coupon payments are tied to company income. Coupons will only be paid if company income is sufficient. Income bonds have higher risk than other bonds
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What are convertible bonds?
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Bonds that can be swapped for a predetermined number of shares of stock before its maturity date. YOU CONVERT IF YOU THINK STOCK PRICES WILL GO UP.
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What is a callable bond?
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Bond that can be called by the company for repurchase before its maturity; If the market changes in favor of the company, you can call bonds back and re-issue at a lower rate
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What is a put bond?
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bond that forces the issuer to buy the bond back prior to maturity
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What is a junk bond?
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Very high risk!!! Same as regular bond, except their issues are poor quality; Generally have poor credit ratings and have a lot of debt; High Risk makes them high return for investors and expensive for corporations
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What is a secured bond?
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less risky; receive some type of asset or collateral (Increase in tax; Mortgage; Collateral)
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What is an unsecured bond?
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Bond that requires premium because it's higher risk (Notes, debentures)
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What is seniority
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indicated preference in position over lenders (if a company defaults, the person with highest seniority gets payments first)
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What is a sinking fund?
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A means of repaying funds that were borrowed through a bond issue. The issuer makes periodic payments to a trustee who retires part of the issue by purchasing the bonds in the open market. It can also be a special fund set aside for the repayment of the bonds principal at maturity
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What is a registered form?
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The bond is issued and the registrar of the company records ownership of each bond
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What is a bearer form?
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The bond is issued without record of the owner's name. A coupon for example is attached and whoever turns in the coupon gets the money
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What is an indenture?
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Written agreement between the corporation (borrower) and its creditors (lenders); AKA a contract. It can also be called a deed of trust
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What is a higher risk going to result in?
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A higher coupon rate
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What is a nominal rate of interest?
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Interest rates or rates of return in which the effects of inflation have not been accounted for
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Real rate of Interest
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Interest rates or rates of return in which the effects of inflation (change in purchasing power) have been accounted for; FOR EXAMPLE: Rate is 5%; Inflation is 2% so 3% is the REAL RATE
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What is an interest rate risk?
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Risk that arises for bond owners from fluctuating interest rates over time; as interest rates go up value of bonds goes down! Whatever the risk is, this will effect your rate
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What are two examples of interest rate risks
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1. The longer the time to maturity, the greater the interest rate risk
2. The lower the interest rate, the greater the interest rate risk. If you have a longer time available for rate change, then the higher the risk is. |
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Good fact to know about: INTEREST AND INFLATION PREMIUMS
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Interest rate premiums and inflation premiums are consistent across the board; If inflation rate is 3%, all bonds are 3%.
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Which one is better
3 years at 8% or 3 years at 5% |
3 years at 8%, there is more opportunity for it to go down
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What is a "Normal" yield curve?
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-Upward sloping yield curve
-long-term rates are higher than short-term rates |
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What is an inverted (Abnormal) Yield Curve
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-downward sloping yield curve
-long-term rates are lower than short-term rates |
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Good to know
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Interest and inflation effects all bonds!
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What is a default premium?
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to compensate investors for the possibility of a default, corporate bonds and municipal bonds must pay a default premium (NOT PAID BY GOVT/TREASURY BONDS THO)
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What is a taxability premium?
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treasuries are exempt from state but not federal taxes! Bonds without a tax exemption will require a premium over those which have tax exemption
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what is liquidity premium?
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while bonds are often traded infrequently, making them not very liquid, treasuries are traded on a regular basis---less liquid bonds will require a premium over bonds with more liquidity
Which would you chose? A: 6% --> Liquid B: 6% --> Not liquid **Chose "A" because "B" pays premium of 6.25% |
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Which will you choose?
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A Bond that is liquid or one that is not liquid (if both had coupon rate of 5%). BOND THATS LIQUID
A bond that does not require federal taxes be paid on coupon payments or one that does (if both had 5.4% coupon rates); DOES NOT REQUIRE FEDERAL TAXES BE PAID ON COUPON PAYMENTS A high risk or low risk bond (both have 5.2% coupon rates) LOW RISK BOND |
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Of all 5 rates, what are the three that require a premium
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1.Default Risk
2.Taxability 3.Lack of Liquidity |
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What type of premium would corporate bonds ALWAYS pay over munis?
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Taxability
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What are the only bonds that will not have a default premium?
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Federal/Treasury Bonds
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True or False; All Bonds with a 7% coupon rate are the same
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FALSE; One may have a 2% taxiblity premium & 1% default premium, the other may have a 1% taxibility premium and 2% default premium
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What are bond ratings solely based on?
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How likely the firm is to default and the protection that creditors have in the event of default
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What are the two leading bond-rating firms?
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Standard and Poor's (S&P)
Moody's |
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What is high grade bond rating?
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Capacity to Pay is EXTREMELY STRONG (GOOD)
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What is medium grade bond rating?
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Capacity to pay is strong, but more susceptible to changes in circumstances
IE: Gas prices go up, may not be able to pay, but more than likely can |
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What is low grade bond rating?
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Gas prices go up we're not sure if they're going to be able to pay or not
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What is very low grade bond rating?
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Income bonds with no interest being paid
Gas Prices go up, they're now paying or they may be already defaulting |
