CH 2 - Fundamentals of Bonds / Corporate Bonds

collateralized mortgage obligation

bond that is secured by a pool of mortgage loans

when a company calls the bond, what happens?

bondholder receives call premium (amount paid on top of par) plus accrued interest, credit worthiness of company improves, and debt to net worth ratio improves

guaranteed bonds

bonds guaranteed by a company other than issuing company.

junk bonds and high yield bonds

bonds issued by companies without a long track record of sales and earnings or with questionable credit strength.

junk bonds - fallen angels

bonds that were issued as investment grade and have been downgraded

three main mortgage bonds

closed end, open end, general

convertible bonds

convert to common shares of stock at option of bondholder

funded debt

corporate debt that is due more than one year from the issue date and includes corporate bonds, notes, and bank loans. it does not include preferred sock, government bonds, or municipal bonds.

spin off

corporate divestiture that results in the subsidary of a company becoming an independent company operating on its own

three basic bond categories

corporate, gov't, municipal

which bond has the highest coupons? lowest? mid range?

corporate, municipal, government

holding company

corporation which owns enough of the voting shares of another corporation that it can influence that company's policies, management, and board of directors

risk with CMOs

credit risk, interest rate and market risk, maturity risk (implied and extension)

current yield equation

current yield = annual interest / current market price

debentures

debt backed by the good faith and credit of the issuing corporation, and are unsecured with no collateral

a longer maturity makes the price _____ when interest rates rise

decline

term bonds

entire issue of bonds that all have the same maturity date

parity bonds

equal claim or rights as other bonds which were previously issued

parity means

equal value, therefore price level of bond or preferred and common stock are worth the same

Most auctions since 2008 have...

failed or been frozen

interest is usually paid on what days?

first and fifteenth

call protection

fixed time period during which bonds may not be called. bondholders want interest rates to decline during call protection period.

low quality bonds have ___ yields and ___ prices

higher, lower

collateral trust certificate

issued by a company that uses securities of other corporation that the issuer owns as collateral. Selected securities are placed on deposit with trustee.

income or adjustment bonds

issued by company in financial difficulty trying to avoid bankruptcy. promise to pay interest only if they have sufficient funds. principal still due at maturity. traded flat (without accrued interest). called adjustment when used in corporate reorganization. considered risky.

low call price is attractive to...

issuer

who do call features help?

issuer

CMO structure

issuer estimates anticipated life of mortgages, distributes cash flow from payment to series of classes of short- med- and long-term maturities called tranches (each with diff life expectancy and level of risk with fixed coupon rate and principal paid in various amounts depending on tranche)

long term bonds are (more, less) risky than short term bonds.

more

are convertibles more or less volatile than non?

more, due to values being tied to stock

general mortgage bond

pledges all mortgageable properties as collateral but does not name any specific lots

when the market price of a bond goes down, YTM goes ____

up

the interest rate is called the coupon rate. is it fixed?

yes, at a percentage of par paid semi annually

if last payment was on fifteenth, there are __ days remaining interest for that month

16

what is a basis point?

1% of par value or $10

the coupon is the fixed interest rate and is calculated as a percentage of the par value of the bond.

...

the yield is the rate of return that an investor receives based on the price paid for the bond.

...

most corporate bonds are traded...

OTC

bonds are rated by credit companies:

Standard and Poor's, Moody's, Fitch

corporate bonds pay interest that is states as...

a percentage of par value. interest is paid semi annually and fully taxable at all levels

zero coupon bond

sold at deep discounts and pay no interest while the bonds are outstanding. no semi annual interest (no accrued), issued at discount (representative of amount of interest but none is paid), increase in value by means of accretion (imputed interest), lump sum maturity payment, taxed annually on increased value without income (phantom income), purchased for accumulation of capital (pension plans), are most volatile, and identified by a zr

conversion price

specific rate of conversion saying how many shares of common stock is received

interest payments ___ after bond is called

stop

a bond purchases at par means yield ____ coupon rate.

equals

five bond structures

series, term, sinking, serial, funded

formula for computing dollar amount accrued interest

(Principal*Rate*Time)/360

if last payment was on first, there are __ days remaining interest for that month

30

planned amortization class (PAC)

CMOs that most resemble bonds due to sinking fund structure (investors receive payment over predetermined period with stable cash flow. PACs have less than average expose to call risk.

primary difference between current yield and YTM

YTM considers time remaining until maturity, unlike current yield

yield

actual rate of return which an invest receives; takes into account purchase price, interest, and redemption value

if interest rates are expected to go up, investors should invest in____ term maturities

shore

accrued interest

amount of interest that has built up since the issuer last made an interest payment and the time the investor buys the bond. when an investor purchases a bond, they pay current market price plus accrued interest. calculated on 30 day month / 360 day year. paid up to but not including settlement date (which is 3 business days after trade date)

when and how are bonds called

at option of issuer on pre established date with pre establish price

changes in yield are measured in...

basis points: 1 bp is equal to .01% or 1/100th of a point (dollar). A change of 1% in yield is equal to 100 bp

if interest rates are expected to decline, investors should increase their call protection, meaning...

buy bonds that are not callable or that have extended call dates

what two things does accrued interest appear on

buyer's and seller's confirmation (added to amount buyer pays and added to amount seller receives)

to calculate parity price...

calculate the conversion ration and use shares produced to determine parity. par value / conversion price = common shares produced market price of bond / common shares produced = parity price of CS

loan collateral

considered liquid assets due to conversion ability and can be therefore used as collateral

during time after getting notice but before call, investors may...

convert the bonds, sell the bonds, wait for the redemption

which bond is the riskiest? safest?

corporate, government

which bond has teh highest yield? lowest? mid range?

corporate, government, municipal

balloon maturity

describes a bond issue with a large amount of the issue that comes due at or near the final maturity date

series bonds

different issue dates and usually have the same term maturity date. used for projects performed in various stages.

bonds can be traded at a...

discount (price is less than par), par (price equals par) or premium (price greater than par)

when the market price of a bond goes up, the YTM goes ___

down

Trust Indenture Act of 1939

federal act that requires that all corporate bonds and debentures e issued under an indentures or deed of trust. it is a document which specifies the rights and duties of the issuer/underwriter/investor. Issue is required to appoint trustee to represent and protect bondholders and their interests.

how is interest taxed on corporate bonds? government? municipal?

fully taxable, exempt from state and local, exempt from all

equipment trust certificates

generally issued by transportation companies to purchase new equipment. secured by the new equipment. trustee holds title to the equipment until the bonds are completely paid at maturity. in event of default, bondholders have first rights to titles. not callable and in serial form. rarely default.

what does the act NOT regulate

government issues, municipal issues, private placements, unit investment trusts

higher the coupon rate, ___ change of call

greater

lower coupons = ____ volatility of price

greater

a bond purchased at a discount means yield ____ coupon rate.

greater than

CMO basics

historically safe, secure income on a monthly basis, and good for all tax brackets

subordinated debentures

hold lesser or junior claim than other debenture bonds and will be paid AFTER higher level debenture is satisfied

interest rate and market risk

if rates decline, cmo prices will increase and mortgages will be refinanced and prepayments will occur. opposite if rates rise.

at their peark ARS were liquid but are considered today to be...

illiquid

how are corporate bonds quoted? government bonds? municipal?

in 1/8, 1/32, 1/8

corporate bonds

instrument of debt by a corporate where bondholders are creditors, not equity owners

mortgage bonds

instrument of debt secured by real property owned by issuing corporation and is the largest type of security issued.

accrued interest in deducted from what?

interest received on the bond by the new owner when calculating the taxable interest received

high call premium is attractive to...

investor

shore sale protection

investor's bonds could be converted into common stock needed to cover short sale position

serial bonds

issue of bonds that have one issue date and staggered maturity dates scheduled at regular intervals until the issue is paid in full. the varying maturities means interest costs to the issuer would progessively go down over the life of teh bonds.

issues of CMOs

issued and collateralized with loans from Ginnie Mae, Fannie Mae, Freddie Max, FHA mortgage loans, or conventional/private mortgage issuers

forced conversion

issuers can be force the conversion of callable convertible securities by issuing a call from bonds at call price below parity price

which bonds are required to register with the SEC?

just corporate

a bond purchased at a premium means yield ____ coupon rate

less than

ARTS may lead to loss of ____

liquidity if auctions fail

credit risk

little or no credit risk due to backing by US gov't. AAA rating. Riskier than treasury securities

convertible bond advantages

loan collateral and short sale protection

if interest rates are expected to go down, investors should invest in ____ term maturities

long

YTM or basis

long term yield on a bond that is expressed as an annual rate. it takes into account purchase price, redemption value, coupon rate and time to maturity.

callable bonds trade at a ____ price

lower

coupon rate of convertible bond is ___ than nonconvertible bonds

lower due to added benefit of conversion allowing holders to participate in possible equity growth

auction will set ____ interest rate offered

lowest

current yield

measurement that takes the bond's current market value and coupon into account. an investor who is interested in purchasing the bond would use current yield as a means to calculate what their actual return would be if they purchased the bond at the current market price

is accrued interest a reason to do a corporate or municipal bond swap

no

is accrued interest included in cost basis?

no

CMO advertising requirements

no comparisons between CMOs and other investments (including CDs), must display final maturity date, must include description of initial issue tranche

does an issuer have to call bonds all at once?

no, they can do a partial call on specific amount of bonds on a random basis for selection

types of bond yields

nominal, current, YTM

bearer

not registered in investor's name and have interest coupons attached to them. to receive interest payments, investor must clip the coupons and present them to an authorized paying agent (usually a bank). Bond are NO LONGER issued in this form.

is conversion taxable

not until stock is sold

prior to calling bonds issuer must give...

notice of call

implied call risk

occurs due to sharp interest rate decline and increase in refinancing. paying off ahead of schedule.

when is the principal repaid

on the maturity date

conversion price formula

par value / common shares produced = conversion price

formula for shares received

par value / conversion Px = common shares received

bonds are loans made in $1000 increments. what is this called

par value or principal

CMO tranche info

pay monthly and are subject to fed and state tax. interest allocated pro rata to each tranche. pay off 1 tranche at a time in order of maturity. Z bond is final tranche and receives no cash until earlier tranches are paid in full. variable tranche rates use LIBOR. trade OTC with markups and downs.

Auction rate securities

preferred stocks and bonds with a long term maturity where dividends or interest rates are reset through a dutch auction every 7, 28, or 35 days.

open end mortgage bond

property can be used to secure subsequent loans and all debts hold equal claims against assets

who issues corporate bonds? government bonds? municipal bonds?

publicly traded organization, federal government, state and local government

corporate auction are generally offered with ___ options whereas municipals are not

put

what can a call price do to limit appreciation possibilities?

put a ceiling on

when interest rates change, prices for short term react _____ and long term react _____

quickest, greatest

junk bonds facts

rated BB or lower, aka high yield bonds, more volatile than investment grade bonds, higher yields, sometimes used to finance takeovers

"As to principal only"

registered in investor's name with interest coupons attached. you must clip coupons and present them to get payment. NO LONGER ISSUED.

registered

registered in the investor's name and interest payments are sent directly to the investor by the paying agent. all bonds currently issued are registered. interest is paid directly to the investor. principal is sent directly to the owner at maturity

forms of bond issues

registered, bearer, "as to principal only"

sinking fund

represents money set aside to redeem the company's bonds, debentures, or preferred stock. [pays up sections of bonds at a time]

anti dilution clause

requires that the conversion price be reduce when a stock dividend is paid.

extension risk

risk that maturity may be extended or end up longer than expected. prepayment of some amount is usually expected. no prepayment messes with this.

M

roman numeral for 1000 and used to signify dollar value of a quantity of bonds. 5M means five thousand dollars worth of bonds

refunding

sale of new issue of bond, the proceeds of which are used to retire outstanding issues. capitalization of corporation doesn't change.

leverage buy out

takeover of a company using borrowed funds. generally, assets of target company are used as security for the loans

CMOs are derivative securities because...

the cash flow of the CMO is dependent upon the performance of the pool of mortgages

nominal yield

the coupon (interest rate) of a bond. It is the fixed amount of annual income an investor will receive from a bond and it is expressed as a percentage

closed end mortgage bond

the property used to secure the loan cannot be used as collateral to secure the other future loans unless they're in a lesser claim

refunds occur when...

there is a sharp decline in interest rates (therefore lower cost of debt) or company wants to reduce prospective dilution effect on common stock shares

Are bonds loans?

yes: you are lending money to organizations but do not represent ownership but debt. bonds are classified as debt securities and the investors as the creditor who receives interest payments.