Finance Chapter 7

Bonds are on the...

Financial Market

When interest rates in the market fall, bond values are likely to increase because of the present value of the bond's remaining cash flows ________.

Increases,

Bond Prices are ______ related to interest rates

Inversely

The federal government can raise money from financial markets to finance its deficits by

Issuing Bonds

Considered free of default risk

treasurys

Difference in equity and debt

- Equity represents ownership interest, while debt does not. -unpaid debt obligations can lead to bankruptcy -dividends paid to equity holders are not tax deductible.

Relationship between nominal interest rate and real interest rate

1+ R = (1+r)*(1+h)

Most accurate fisher method

1+R = (r+1)*(h+1)

In terms of maturity U.S. Treasury notes and bonds have initial maturities ranging from ______.

2 to 30 years

Current yield equation

= Annual coupon payment / bond price

coupon payment

= face value * coupon rate / m (# of int payments per year)

Coupon Rate Formula

= percentage of par value

Corporate Bond's YTM

Changes over time, and can be greater than, equal to , or less than the bond's coupon rate.

The only risk address by bond ratings

Default risk

The relationship between market interest rates and bond values is

Negative. When interest rates rise, bond value decreases.

What is required to calculate the current value of a bond?

Par Value, Applicable market rate, time remaining to maturity, coupon rate

fisher effect calculations

R = nominal interest rate r= real rate of interest h = actual or expected change in prices (inflation) during interest period

Treasury bills (T-Bills)

Short term, traded on money markets, zero coupon, pure discount

When the coupon rate equals the required rate, the bond will sell for its par value

TRU

Return = Yield

TRUE

the greater the term to maturity, the greater the risk

TRUE

Why does a bond's value fluctuate over time?

The market interest rates vary, which causes the bond's value to change. The coupon rate and par value are fixed.

T/F: Equity represents an ownership interest

True

nominal includes

appropriate interest rate premiums

nominal interest rate

determines the percentage changes in number of dollars

Nominal interest rate

includes inflation

The written agreement between the corporation and the lender detailing the terms of the debt issue is the ______.

indenture

Companies are motivated to call their bonds when ________ _________ falls

interest rates

Corporate bonds coupon rate are

is fixed until the bond matures (some have floating rates, but most are fixed)

Treasury Notes and bonds

long term, capital markets, interest-only, semiannual

Zero coupon bond is a bond that ______

makes no interest payments

Real interest rate

measures change in purchasing power

Floating rates adjust _____.

periodically

Debt holders have _____ over equity holders

priority, in event of liquidation: employees & customers, govs next, creditors, and then equity holders

Two forms of long-term debt

public issue/ privately placed

Approximate fisher method

r = R-h

What is the real rate of return

rate that has been adjusted for inflation

when the coupon rate is less than the rate of return

the bond sells for less than par. (the borrowers only receive 950 and repay 1000)

the lower the coupon rate

the greater the interest rate risk

Interest Rate Risk (maturity Risk)

the market interest rate and the bond's price are inversely related.

Included in bond indenture

total amount borrowed, face value of each bond, time until maturity, seniority, whether registered or bearer bonds, seniority, collateral, repayment options, protective covenants