SIE Chapter 4-- Intro to Debt Instruments
A U.S. government bond is selling in the market at 95.28. The dollar value of this bond is:
$ 958.75 U.S. government bonds are quoted as a percentage of par with a fraction in 32nds of a point. Therefore, a T-bond quoted at 95.28 is equal to 95 28/32. By converting the fraction to a decimal, the quote becomes which is 95.875% of the par value of $1,000. $1,000 x 95.875% = $958.75.
If a bond is called at 103.75, how much will an investor receive?
$1,037.50 plus accrued interest Bond prices are quoted in percentages of par. A bond with a call price of 103.75 is callable at 103.75% of par value. Since the par value for most bonds is $1,000, when this bond is called, the issuer must pay $1,037.50 ($1,000 x 103.75%) to each investor. However, if a bond is called before it matures or is sold prior to maturity, the seller is also entitled to accrued interest.
A 5% $1,000 par value bond sells at $900 and matures in 10 years. What is the amount of each interest payment?
$25 Bonds pay interest every six months (semiannually). The dollar amount of interest payments is computed as a percentage of the par value. In this example, the coupon rate is 5%. The annual interest payment is $50 (5% of $1,000 par value). Each interest payment is one-half of that amount, or $25.00.
points
1% of bond's par value (or $10) corporate and municipal bonds trade 1/8 points Treasury bonds trade 1/32 points
Conversion steps
1) determine conversion ratio (amt of shares redeemable per bond) = par value/conversion price 2) conversion value = number shares * Price per share 3) compare conversion value to call value
Bond Pricing
1) percentage of par value (price of 100 is bond trading at par($1,000)) 2) points (price of 99 is bond trading at $990) - corp & municipal bonds trade at 1/8ths (87 1/8 = - treasury notes and bonds trade at 1/32nds (99.08 = 99 8/32 = 99.250 = $992.50) (note: t-bills trade on a yield basis)
A convertible bond has a conversion price of $50 and is currently selling in the market at $1,100. The conversion ratio is:
20 To find the conversion ratio of a convertible bond, the bond's par value ($1,000) is divided by the conversion price ($50). In this question, the conversion ratio is 20 ($1,000 ÷ $50). To calculate the conversion ratio, the market price of the bond is irrelevant.
Crunch Time Fact #7
A call feature on a bond is most advantageous for the issuer (NOT the bondholders)
If a bond offering is issued with a call provision, it's MOST beneficial to:
An issuer that does not want to make the same interest payment until maturity A call provision on a bond offering allows the issuer to redeem its outstanding bonds before they reach maturity. The benefit to the issuer is that it will no longer be required to make periodic interest payments once the bond issue has been called. Issuers often call their bonds back due to a decline in interest rates.
Who derives the MOST benefit from a put provision attached to a bond offering?
Bondholders A put provision allows the bondholder to redeem the bond on a specified date (or dates) prior to maturity. This provision is most likely to be utilized if market interest rates rise.
Crunch Time Fact #3
Bonds with short-term maturities minimize interest-rate risk (i.e., they move less than long-term bonds)
Which of the following statements is TRUE if interest rates rise?
Both bond and bond fund prices will fall Bond prices and interest rates move in the opposite direction. When interest rates rise, bond prices will fall and vice versa. Bond funds are simply mutual funds that invest in bonds. Bond fund prices will also move in the opposite direction as interest rates fluctuate.
Crunch Time Fact #9
Call protection is most valuable for a bondholder if bond prices are rising (due to interest rates falling)
Crunch Time Fact #1
For bonds, 1 basis point is equal to 1/100 of 1% (100 basis points equals 1%)
Crunch Time Fact #6
If bond prices are falling, it's because interest rates are rising (and vice versa)
Crunch Time Fact #5
If interest rates fall, a money-market fund will experience a stable value, but a decrease in yield
Crunch Time Fact #2
If interest rates fall, long-term bonds and long-term bond funds will increase the most in value
A bond is selling at a premium. This indicates that:
Interest rates have decreased since the bond was issued The amount that the market price exceeds the par value is known as a premium. One reason for selling at a premium is a decrease in interest rates after the bonds were issued. When looking at the yields for premium bonds, the nominal yield is the highest, followed by the current yield, with the yield to maturity being the lowest yield of the three.
Crunch Time Fact #8
Long-term bonds have a longer duration than short-term bonds
The call premium of a bond refers to the amount:
Over par value that the issuer must pay to exercise the call privilege The call premium of a bond refers to the amount the issuer must pay in excess of par value to exercise the call privilege. For example, if a bond is callable at 102, it has a 2 point ($20) call premium. The issuer must pay $1,020 ($20 more than par) if it wishes to call in the bond.
If an investor wants to build a bond portfolio that maintains a stable value, she should purchase bonds with:
Short maturities Although short-term bonds are influenced by changing interest rates, the effect is relatively minor due to their short-term nature. For that reason, investors who want stability in their bond portfolios should invest in short-term debt
Crunch Time Fact #4
Stability in the value of a debt portfolio is the greatest when the debt securities have short maturities
A decrease in which of the following would cause the price of a bond to increase?
The general level of interest rates Interest rates and bond prices are inversely related. When interest rates increase, bond prices will fall. When interest rates decrease, bond prices will rise. A decrease in a bond's rating choice (a), a bond's liquidity choice(b), or an issuer's financial strength choice (d), would usually have a negative effect on a bond's price
Crunch Time Fact #10
The last transaction in ABC 4.75s 2028 was at 101 1/2. The bond trade was priced at a premium (i.e., 101 1/2). 4.75s is the bond's coupon of 4.75% and its maturity is in 2028.
call protection
The time during which the issuer of the bond is not allowed to exercise the call option.
For a bond owner, in which of the follow situations is call protection most valuable?
When bond prices are rising Call protection prevents an issuer from calling (i.e., buying back) their bonds. If bonds are ultimately called, investors must sell their bonds back to the issuer. Bonds are most often called when their prices have risen due to declining interest rates.
Which of the following bonds has an interest payment which remains unchanged until maturity?
Zero-coupon bond For most bonds, the interest rate or payment is set at the time of issuance and generally remains fixed for the life of the bond. However, in some cases, as interest rates move up or down, the coupon rate will be adjusted to reflect market conditions. These adjustable rate bonds may be referred to as variable or floating rate bonds. A zero-coupon bond is one that makes no periodic interest payments during its life. In other words, the interest amount (zero) remains unchanged.
The most recent transaction in ABC 6.50x 2050 was at 95. This bond is trading at:
a discount The bond's last trade was done at a price of 95 or 95% of par, which is a discount. The 6.50 represents the bond's interest rate and 2050 is the bond's maturity date. The "x" is simply a placeholder and doesn't give any information about the bond.
call provision
a provision in a bond contract that gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date
call premium
additional amount paid to holder to compensate for early redemption
Par value
aka face value, principal amount issuer agrees to pay the investor when the bond matures
Accrued Interest
amount of interest seller is entitled to receive and amount the buyer is required to pay for a bond being sold in secondary market
Current Yield
annual interest / current market price
Tax consequences of converting bonds to stock
conversion is not taxable taxes will only arise when investor sells acquired shares
Dated Date
date on which interest on a new bond issue begins to accrue used when new bond issues don't fall on the 1st or 15th
Municipal bond rating organizations are concerned primarily with the risk of:
default Municipal bond rating organizations, such as S&P and Moody's, are concerned primarily with the risk of default or the risk of the issuer not being able to pay interest and/or principal.
put provision
grants right to sell (put) the bond to the issuer at a specified price prior to maturity.
Who derives the MOST benefit from a call provision attached to a bond offering?
issuers A call provision allows the bond issuer to redeem its outstanding bonds before they reach maturity. The benefit to the issuer is that, if the bond is called, it's no longer required to make periodic interest payments.
A bond is selling at a discount and yields have remained constant. As the bond gets closer to its maturity, what happens to its price?
it increases Although fixed income securities are subject to some degree of interest rate risk, that risk is of less concern if the bond is being held to maturity. Assuming there is no default by the issuer, the price of a bond that is selling at a discount will increase (move towards par value) as it gets closer to maturity.
Leverage Financing
raising capital through debt
Yield to Call (YTC)
return a bondholder receives if the bond is held until the call date
For a bond, what does a call provision describe to investors?
the call date and call price For a bond, the call provision is a part of a bond's indenture and stipulates the bond's call date and call price.
Coupon Rate (Nominal Yield)
the interest paid on a bond, expressed as a percentage of the bond's par value
The value of the conversion feature on a convertible bond is determined by:
the stock price Convertible bonds can be converted into a pre-determined number of shares of the issuer's common stock (i.e., conversion ratio). Investors will likely convert their bonds if the price of the stock rises or is expected to rise. The other features on a bond (e.g., its maturity date or interest rate) will not have as significant an impact on the value of the conversion feature.
Debt Service
total of all interest payments over the bond's life and the final repayment of the loan value (principal) at maturity
Yield to Maturity (YTM)
total return anticipated on a bond if the bond is held until it matures
If market interest rates increase, the prices of outstanding bonds:
will decrease Bonds are subject to interest-rate risk. Interest-rate risk implies that as market rates increase, investors will not be interested in purchasing existing bonds at par since they're able to obtain higher yields by purchasing new bonds. Therefore, existing bonds will need to be offered at a discounted price in order to attract purchasers. In other words, if interest rates increase, outstanding bond prices will decrease. Conversely, if interest rates fall after a bond has been issued, the bond will likely trade at a premium to par.
