Chapter 7
Coupon Payment
(Pmt)= Stated interest payment made on the bond
Face Value
(par value) = typically $1,000
Security
(what is backing up the terms of the bond) collateral mortgage debentures notes
If YTM < Coupon rate then par value ____ Bond price
<
Maturity
= Specified date on which the principal amount of the bond will be repaid
If YTM = coupon rate, then par value __ bond price
= bond price
Bond
= debt security. Usually an interest-only loan
If YTM < coupon rate, then par value < bond price -Why?
Higher coupon rate causes value above par -Price above par value, called a premium bond
discount bond
If a bond sells for LESS than its face value Its yield to maturity is HIGHER than the coupon rate.
premium bond
If a bond sells for MORE than its face value Its yield to maturity is LOWER than the coupon rate.
Consider a bond with a 10% annual coupon rate, 15 years to maturity and a par value of $1,000. The current price is $928.09. Will the yield be more or less than 10%?
Nper = 15; PV = -928.09; FV = 1,000; PMT = 100 CPT Rate = 11%
If YTM = coupon rate, then par value = bond price •If YTM > coupon rate, then par value > bond price -Why?
The discount provides yield above coupon rate -Price below par value, called a discount bond
companies pay rating agencies such as Moody's and S&P to rate their bonds, and the costs can be substantial. however, companies are not required to have their bonds rated; doing so is voluntary. why do you think they do it?
an issuer will gladly pay a rating agency to rate its bonds, so that investors will have a better idea of what a bond is worth, and purchase it if it meets their investment needs. Unrated bonds essentially pose a mystery to investors who then must do their own research into the issuer's credit worthiness. the chances of a rated bond being sold to investors is much greater than unrated bonds, all else equal.
Which bonds will have the higher coupon, all else equal? A callable bond versus a non-callable bond:
callable bond is unattractive and cheaper
A bond can be a premium bond at a _____________ time and become a ____________ bond at a later time (or vice versa).
certain discount
________ never changes ________ does change
coupon rate YTM
As bond prices rise, the yield to maturity
decreases
The present value of a bond is calculated by
discounting the interest payments (coupons) and face value at the current market rate.
As bond prices fall, the yield to maturity
increases
Yield to Maturity (YTM)
is the rate of total return that a purchaser of a bond will receive if he/she holds the bond until maturity.
If a bond sells at face value, its YTM is equal to
its coupon rate
Higher yield-> __________ price
lower
the coupon rate _________ ________ after a bond is issued
never changes
is it true that a US treasury security is risk-free?
nothing is totally risk free. it is possible that someday the US government might default on its bonds, but it has never done so, nor are there any signs it is likely to even coming close to doing do in the foreseeable future. US treasury securities are closer to being completely risk-free than any other4 security in the investment market, therefore they are a good proxy for a "risk-free" asset.
Bond prices/values and interest rates always move in ____________ directions. They have an ___________ relationship
opposite Inverse
If YTM > Coupon rate then par value ____ Bond price
par value > bond price
Seniority
position in the capital structure
Liquidity premium
represents compensation for lack of liquidity. Bonds that have more frequent trading will generally have lower required returns
Default risk premium
represents compensation for the possibility of default
The coupon rate depends on
risk characteristics of the bond when issued
Collateral
secured by firm assets
Mortgage
secured by real property, normally land or buildings
bearer form
the form of bond issue in which the bond is issued without record of the owner's name; payment is made to whomever holds the bond similar to money
registered form
the form of bond issue in which the registrar of the company records ownership of each bond; payment is made directly to the owner of record registered electronically that you own the bond
Call provisions
the issuer can forcibly by that bond back from you during a specified time period. Negative for investor, good for the issuer
Anything else that affects the risk of the cash flows to the bondholders will affect
the required returns
Debentures
unsecured bonds unsecured debt, usually with a maturity of 10 years or more
Notes
unsecured debt with original maturity less than 10 years
Which bonds will have the higher coupon, all else equal? Subordinated debenture versus senior debt:
willing to pay less for subordinated because there's more risk
Which bonds will have the higher coupon, all else equal? Secured debt versus a debenture:
willing to pay more for secured debt, more attractive
Which bonds will have the higher coupon, all else equal? A bond rated AA versus a bond rated A:
AA is less risky, so higher price, more attractive
bond indenture
Contract between the company and the bondholders
Zero Coupon Bonds
Make no periodic interest payments (coupon rate = 0%) •The entire yield-to-maturity comes from the difference between the purchase price and the par value •Sometimes called zeroes, deep discount bonds, or original issue discount bonds (OIDs) •Treasury Bills and principal-only Treasury strips are good examples of zeroes
Coupon Rate
Stated in the indenture (contract) Coupon rate: coupon rate/1000 on exam (always assume the denominator is 1000)
How does a bond issuer decide on the appropriate coupon rate to set on its bonds? Explain the difference between the coupon rate and the required return on a bond.
issuers of bonds must ensure that investors will receive the rate of return that they require for purchasing the bonds, otherwise the bonds will not sell. If the bonds are to be issued at par value (which is usually, but not always the case), then the coupon rate must equal the required rate of return. Determining investor's required rate of return is not an exact science (the market will make this judgment!), but doing a thorough job of research should give the issuer a pretty good idea of what investors are expecting. If the issuer estimates that investors will require a return of, for example, 6% in order to purchase the bonds, it will have to set the semi-annual coupon payments at $30 (6% of $1000 par value = $60/2 for semi annual payments). the coupon rate is what investors who buy the bond at par value will receive as a rate of return if they hold the bond to maturity. The yield o maturity essentially adjusts the coupon rate to account for a capital gain or loss (difference between buying price and price received at maturity) that occurs when the market price of the bond either rises above or falls below par value.
when doing zero coupon bonds you always have to assume what kind of payments?
semiannual