Lecture 2: Comparing Interest Rates/Bonds

Debt securities can also be classified in terms of seniority

(senior vs. junior).

◦Convertible bonds

- A convertible bond can be swapped for a fixed number of shares of stock anytime before maturity at the holder's option.

Bonds can be repaid

- At maturity. - In part or in entirely before maturity.

◦Corporate Bonds

- Debt securities issued by corporation.

◦Government Bonds

- Debt securities issued by government. - Treasury Bonds, Treasury Bills, Exchange Fund Notes

◦A positive covenant specifies an action the company agrees to take. Example

- The firm must maintain any collateral in good condition.

A bond indenture is a contract between the corporation (borrower) and its creditors (bondholders) that includes

1. the basic terms of the bonds 2. the total amount of bonds issued 3. a description of assed used as security 4. the repayment agreements 5. Call provisions 6. Details of protective covenants

A debenture is an unsecured debt usually with a maturity of __

10 years or more.

A typical credit card agreement quotes an interest rate of 18% APR. Monthly payments are required. What is the actual interest rate you pay on such a credit card?

An APR of 18% with monthly payments is 0.18/12=0.015 per month. EAR=(1+0.015)^12-1=0.1956

Floating rate bond

Bond whose coupon rate floats depending on some index value.

registered bonds

Bonds owned by investors whose names and addresses are recorded by the issuer; interest payments are made to the registered owners.

Maturity

Date on which the principal amount of the bond is repaid.

◦The 10% interest rate in the slide 4 (10% a year compounded semiannually) is called the quoted interest rate. ◦The Effective Annual Rate (EAR) is the interest rate expressed as if it were compounded once per year.

EAR=(1+(Quoted rate)/m )^m-1

Discuss the difference between registered form bond and bearer form bond?

For registered form bond, the registrar of the company records the ownership of each bond and payment is made directly to the owner of record. For bearer form bond, the bond is issued without record of the owner's name and payment is made to whomever holds the bond.

Types of Bonds:

Government Bonds, Corporate Bonds, Zero Coupon Bonds, Floating Rate Bonds, Convertible bonds

A bank is offering 12% a year compounded quarterly. If you put $100 in an account, how much will you have at the end of two year?

Interest rate per period= 0.12/4=0.03 FV=PV(1+r)^t FV=PV(1+r)^t=100(1+0.03)^8=$126.68

Computing Interest Rate per Period

Interest rate per period= i/m

Coupon

Stated interest payment made on a bond

Face Value/Par Value

The Principal amount of a bond that is repaid at the end of the term.

Coupon rate

The annual coupon divided by the face value of the bond.

A company is contemplating a long-term bond issue. It is debating whether to include a call provision. What are the benefits to the company from including a call provision? What are the costs?

The company can take advantage of interest rate declines by calling in an issue and replacing it with a lower coupon issue, hence lowering the company cost of borrowing. The cost to the company is that it may have to buy back the bond at a higher price (call price is higher than the face value).

Face value

The principal amount of a bond that is repaid at the end of the term.

Discuss the ways a company can repay the bond?

There are several ways a company can repay the bond, the first is to repay at maturity. The company will continue to pay the coupon each periods and the face value at maturity. Alternatively, the company can set up a sinking fund account. Make annual contribution to the account and buy back a portion of the outstanding bonds issue from the market annually. Finally, if there is a call provision in the bond indenture, the company can exercise the option and repurchase the bond at the call price prior to maturity.

bearer form bond

a bond issued without record of the owner's name; payment is made to whomever holds the bond

Debt securities are classified

according to the collateral and mortgages used to protect the bondholders.

A call premium is the

amount by which the call price exceeds the face/par value of a bond.

A sinking fund is

an account managed by the bond trustee for early bond redemption.

Interest rate per period= I/m I is

annual rate

Convertible bond

can be swapped for a fixed number of shares of stock anytime before maturity at the holder's option.

Collateral is

commonly used to refer to any asset pledged on a debt.

◦APR does not take _____ into consideration.

compounding

A call provision is an agreement

giving the corporation the option to repurchase a bond at a specified price (call price) prior to maturity.

◦Where reference is made to an interest rate, institutions should also indicate the AnnualisedPercentage Rate (APR). An APR

is a reference rate which includes the basic interest rate and other fees and charges of a product expressed as an annualised rate.

A protective covenant is that part of the indenture that

limits certain actions a company might otherwise wish to take during the term of the loan.

Negative covenant

limits/prohibits actions the company might take during the term of the loan to protect the bondholder.

A negative covenant

limits/prohibits actions the company might take. Examples are - the firms cannot issue additional long-term debt - the firms cannot sell any major assets without lenders' approval.

Interest rate per period= I/m m is

number of compounding period

Bonds can be classified as

registered or bearer form

Some bonds are

secured by collateral (e.g. mortgage bonds)

Bonds are debt securities. A debt represents ____

something that must be repaid: it is the result of borrowing money.

Unpaid debt is a liability of the firm. If it is not paid,

the creditors can legally claim the assets of the firm.

A note is an unsecured debt usually with a maturity of ___

under 10 years.

Debtholder generally do not have _______.

voting power

•Zero Coupon Bonds

•- A bond that makes no coupon payments and is initially priced at a deep discount

•Floating rate bonds

•- Coupon rate floats depending on some index value.