Chapter 5

real rates

Real rates are rates that have been adjusted or inflation

inflation premium

investors demand compensation or this loss in the orm o higher nominal rates.

debenture

unsecured bond, for which no specific pledge of property is made

main differences between debt and equity

1 Debt is not an ownership interest in the firm 2.The corporation's payment of interest on debt is considered a cost o doing business and is fully tax deductible. Dividends paid to stockholders are not tax deductible. 3 Unpaid debt is a liability of the firm

zero coupon bonds

A bond that pays no coupons at all must be offered at a price that is much lower than its stated value

face value or par value

The amount that will be repaid at the end of the loan

repayment

Bonds can be repaid at maturity, at which time the bondholder will receive the stated, or face, value of the bond, or they may be repaid in part or in entirety before maturity.

value of a bond

C x [1 - 1/(1 + r ) t ]/ r + F /(1 + r ) t

terms of bond

Corporate bonds usually have a ace value (that is, a denomination) o $1,000. This is called the principal value and it is stated on the bond certicate. So, i a corpo- ration wanted to borrow $1 million, 1,000 bonds would have to be sold. The par value (that is, initial accounting value) o a bond is almost always the same as the ace value, and the terms are used interchangeably in practice.

security

Debt securities are classied according to the collateral and mortgages used to protect the bondholder

debt securities

Debt securities are typically called notes, debentures , or bonds . Strictly speaking, a bond is a secured debt. However, in common usage, the word bond refers to all kinds of secured and unsecured debt.

call premium

Generally, the call price is above the bond's stated value (that is, the par value). The difference between the call price and the stated value is the call premium

taxability premium

Investors demand the extra yield on a taxable bond as compensation for the unfavorable tax treatment.

default risk premium

Investors rec- ognize that issuers other than the Treasury may or may not make all the promised payments on a bond, so they demand a higher yield as compensation or this risk.

nominal rates

Nominal rates are called "nominal" because they have not been adjusted for infation.

interest rate risk premium

The longer the term to maturity, the greater is the interest rate risk, so the interest rate risk premium increases with maturity

dirty price

The price you actually pay, however, includes the accrued interest. This price is the dirty price , also known as the "ull" or "invoice" price.

collateral

general term that frequently means securities (for example, bonds and stocks) that are pledged as security for payment of debt

coupons

interest payments made are called the bond's coupons . Because the coupon is constant and paid every year, the type of bond we are describing is sometimes called a level coupon bond

yield to maturity (YTM)

interest rate required in the market on a bond

clean price

meaning that accrued interest is deducted to arrive at the quoted price.

berer form

means that the certificate is the basic evidence of ownership, and the corporation will "pay the bearer." Ownership is not otherwise recorded, and, as with a registered bond with attached coupons, the holder of the bond certicate detaches the coupons and sends them to the company to receive payment.

fisher effect

named after the great economist Irving Fisher. Because investors are ultimately concerned with what they can buy with their money, they require compensation for infation.

bond

normally an interest-only loan, meaning that the borrower will pay the interest every period, but none of the principal will be repaid until the end of the loan.

time to maturity

number of years until the face value is paid

registered form

recorder

mortgage securities

secured by a mortgage on the real property o the borrower. The property involved is usually real estate, or example, land or buildings. The legal document that describes the mortgage is called a mortgage trust indenture or trust deed .

seniority

seniority indicates preference in position over other lenders, and debts are sometimes labeled as senior or junior to indicate seniority

floating rate bonds

the coupon payments are adjustable.

sinking fund

account managed by the bond trustee for the purpose of repaying the bonds.

long term debts

all long-term debt securities are promises made by the issuing rm to pay principal when due and to make timely interest payments on the unpaid balance

call provision

allows the company to repurchase, or "call," part or all o the bond issue at stated prices over a specic period. Corporate bonds are usually callable.

put bond

allows the holder to force the issuer to buy the bond back at a stated price

coupon rate

annual coupon divided by the face value

current yield

bond's annual coupon divided by its price

structured notes

bonds that are based on stocks, bonds, commodities, or currencies. One particular type of structured note has a return based on a stock market index

liquidity premium

less liquid bonds will have higher yields than more liquid bonds.

protective covenants

part of the indenture or loan agreement that limits certain actions a company might otherwise wish to take during the term of the loan. Protective covenants can be classified into two types: negative covenants and positive (or affirmative) covenants.

income bonds

similar to conventional bonds, except that coupon payments are dependent on company income.

convertible bond

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

term structure of interest rates

tells us what nominal interest rates are on default-free, pure discount bonds of all maturities.

note

usually debenture if the maturity of the unsecured bond is less than 10 or so years when the bond is originally issued

indenture

written agreement between the corporation (the borrower) and its creditors. It is sometimes referred to as the deed of trust . Usually, a trustee (a bank per- haps) is appointed by the corporation to represent the bondholders.