Chapter 7 Finance terms
face value
Amount of principal due at the maturity date of the bond
Summary of chapter 7
1. Determining bond prices and yields is an application of basic discounted cash flow principles. 2. Bond values move in the direction opposite that of interest rates leading to potential gains or losses for bond investors. 3. Bonds have a variety of features spelled out in a document called the indenture. 4. Bonds are rated based on the default risk. Some bonds such as treasury bonds have no risk of default where as so-called junk bonds have substantial default risk. 5. A wide variety of bonds exist many of which contain exotic or unusual features. 6. Almost all bond trading is OTC, with little or no market transparency in many cases. As a result, Bond price and volume information can be difficult to find for some types of bonds. 7. Find heels in interest rates reflect the effect of six different things: The real interest rate and five premiums that investors demand as compensation for inflation, interest rate risk, default risk, taxability, and lack of liquidity.
floating rate bonds
Coupon paymetns adjust periodically according to an index such as the T-bill rate or the rate on other treasury issues.
warrant
The bond buyer has a right to purchase shares of stock in the company at a fixed price.
Puttable bonds
The holder has the right to sell the bond back to the issuer at a stated price.
default risk premium
The portion of a nominal interest rate or bond yield that represents compensation for the possibility of default
bid price
The price a dealer is willing to pay for a security. Investor's selling price dealer's buying price.
asked price
The price a dealer is willing to take for a security. Investor's buying price as dealer's selling price.
dirty price
The price of a bond including accrued interest, also known as the full or invoice price. This is the price the buyer actually pays.
maturity
The specified date on which the principal amount of a bond is paid
Indenture
The written agreement between the corporation and the lender detailing the terms of the debt issue
call protected bond
a bond that, during a certain period, cannot be redeemed by the issuer
current yield
a bond's annual coupon divided by its price
deferred call provision
a call provision prohibiting the company from redeeming a bond prior to a certain date
protective covenant
a part of the indenture limiting certain actions that might be taken during the term of the loan, usually to protect the lender's interest
treasury yield curve
a plot of the yields on treasury notes and bonds relative to maturity
sinking fund
an account managed by the bond trustee for early bond redemption
call provision
an agreement giving the corporation the option to repurchase a bond at a specified price prior to maturity
Debenture
an unsecured debt, usually with a maturity of 10 years or more
note
an unsecured debt, usually with a maturity under 10 years
convertible bonds
can be traded for a fixed number of shares of stock
income bonds
coupon is paid if income is sufficient
real rates
interest rates or rates of return that have been adjusted for inflation
Nominal rates
interest rates or rates of return that have not been adjusted for inflation
call premium
the amount by which the call price exceeds the par value of a bond
coupon rate
the annual coupon divided by the face value of a bond
interest rate risk premium
the compensation investors demand for bearing interest rate risk
bid-ask spread
the difference between the bid price and the asked price
bearer form
the form of bond issue in which the bond is issued without record of the owner's name; payment is made to whomever holds the bond
registered form
the form of bond issue in which the registrar of the company records ownership of each bond; payment is made directly to the owner of record
liquidity premium
the portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity
taxability premium
the portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status
inflation premium
the portion of a nominal interest rate that represents compensation for expected future inflation
clean price
the price of a bond net of accrued interest; this is the price that is typically quoted
Yield to Maturity (YTM)
the rate required in the market on a bond
Term structure of interest rates
the relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money
Fisher effect
the relationship between nominal returns, real returns, and inflation
Coupon
the stated interest payment made on a bond
