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