Finance Chapter 7
Bonds are on the...
Financial Market
When interest rates in the market fall, bond values are likely to increase because of the present value of the bond's remaining cash flows ________.
Increases,
Bond Prices are ______ related to interest rates
Inversely
The federal government can raise money from financial markets to finance its deficits by
Issuing Bonds
Considered free of default risk
treasurys
Difference in equity and debt
- Equity represents ownership interest, while debt does not. -unpaid debt obligations can lead to bankruptcy -dividends paid to equity holders are not tax deductible.
Relationship between nominal interest rate and real interest rate
1+ R = (1+r)*(1+h)
Most accurate fisher method
1+R = (r+1)*(h+1)
In terms of maturity U.S. Treasury notes and bonds have initial maturities ranging from ______.
2 to 30 years
Current yield equation
= Annual coupon payment / bond price
coupon payment
= face value * coupon rate / m (# of int payments per year)
Coupon Rate Formula
= percentage of par value
Corporate Bond's YTM
Changes over time, and can be greater than, equal to , or less than the bond's coupon rate.
The only risk address by bond ratings
Default risk
The relationship between market interest rates and bond values is
Negative. When interest rates rise, bond value decreases.
What is required to calculate the current value of a bond?
Par Value, Applicable market rate, time remaining to maturity, coupon rate
fisher effect calculations
R = nominal interest rate r= real rate of interest h = actual or expected change in prices (inflation) during interest period
Treasury bills (T-Bills)
Short term, traded on money markets, zero coupon, pure discount
When the coupon rate equals the required rate, the bond will sell for its par value
TRU
Return = Yield
TRUE
the greater the term to maturity, the greater the risk
TRUE
Why does a bond's value fluctuate over time?
The market interest rates vary, which causes the bond's value to change. The coupon rate and par value are fixed.
T/F: Equity represents an ownership interest
True
nominal includes
appropriate interest rate premiums
nominal interest rate
determines the percentage changes in number of dollars
Nominal interest rate
includes inflation
The written agreement between the corporation and the lender detailing the terms of the debt issue is the ______.
indenture
Companies are motivated to call their bonds when ________ _________ falls
interest rates
Corporate bonds coupon rate are
is fixed until the bond matures (some have floating rates, but most are fixed)
Treasury Notes and bonds
long term, capital markets, interest-only, semiannual
Zero coupon bond is a bond that ______
makes no interest payments
Real interest rate
measures change in purchasing power
Floating rates adjust _____.
periodically
Debt holders have _____ over equity holders
priority, in event of liquidation: employees & customers, govs next, creditors, and then equity holders
Two forms of long-term debt
public issue/ privately placed
Approximate fisher method
r = R-h
What is the real rate of return
rate that has been adjusted for inflation
when the coupon rate is less than the rate of return
the bond sells for less than par. (the borrowers only receive 950 and repay 1000)
the lower the coupon rate
the greater the interest rate risk
Interest Rate Risk (maturity Risk)
the market interest rate and the bond's price are inversely related.
Included in bond indenture
total amount borrowed, face value of each bond, time until maturity, seniority, whether registered or bearer bonds, seniority, collateral, repayment options, protective covenants