Unit 9

Maturity

The period of time over which the borrower pays all required payments.

Reinvestment Rate

The rate an investor earns from investing coupon payments in newly issued bonds of the same corporation. When discussing risk assessment, the reinvestment rate is assumed to be the same rate as the bond's market rate.

Required Market Rate of Return (k)

The rate investors require the bond to pay in order to purchase it. A bond's market rate is generally different from the coupon rate and is the rate used to calculate the present value of the bond (discount the future cash flows of the bond to the present).

Effective Annual Yield (EFF)

The rate of interest equivalent to the periodic interest rate compounded over the number of periods per year. The EFF is also called the effective annual rate (EAR).

Capital Gains Rate

The rate of return derived from buying a bond and selling it at a higher price. If the sale price of the bond is lower than its purchase price, then a capital loss (negative capital gain) is incurred.

Bond

A financial asset that provides its holder with periodic fixed interest payments (called coupon payments) and a lump sum payment at maturity equal to the face value of the bond. Bonds constitute a major source of fund raising for corporations and governments.

Premium Bonds

Bonds that sell at a price higher than their par value. Bonds sell at a premium when the required market rate on the bond drops below the bond's coupon rate.

Discount Bonds

Bonds that sell at a price low than their par value. Bonds sell at a discount when required market rate rises above the bond's coupon rate.

Maturity Date

The date on which a bond contract expires and on which the bond issuer must pay the bondholder the last coupon payment plus the pay or face value of the bond. (Also called at maturity)

Par Value (or Denomination)

The face value of the bond at the time it is issued. It is also the final amount that the bond issuer must pay the bondholder (in addition to the last coupon payment) at maturity. A bond's price may differ from its par value over the life of the bond due to interest rate fluctuations.

Coupon Payment

The interest payment made to investors on a periodic basis and is calculated as the periodic coupon rate times the bond's par value.

Maturity Risk

The longer the life of a bond, the more vulnerable it is to price and reinvestment risk.

Yield to Maturity (YTM)

The rate of return earned on a bond that is held to maturity.

Term to Maturity

The remaining periods before a bond reaches its maturity date.

Interest Rate Risk

The risk associated with changes in market interest rates. Interest rate risk has two components: price risk and reinvestment risk.

Price Risk

The risk associated with the variability in bond prices due to changes in market interest rates.

Reinvestment Risk

The risk that an investor may suffer a decline in income derived from a bond's coupon payments due to a decrease in the bond's market interest rate.

Coupon Rate

The stated annualized interest rate a bond issuer pays a bondholder on a periodic basis, usually annually or semiannually. Typically, the coupon rate remains constant for the life of the bond.