Podcast
Questions and Answers
What causes bond values to decrease when market interest rates rise?
What causes bond values to decrease when market interest rates rise?
- Increased demand for safer investments
- Higher yields offered by alternative investments (correct)
- Increased default risk of the bond issuer
- Bonds become less liquid
What does liquidity risk in the context of bonds refer to?
What does liquidity risk in the context of bonds refer to?
- The potential for negative yields on the bond
- The inability to sell the bond without significant losses (correct)
- The risk of interest rates changing
- The issuer's inability to make interest payments
What is the primary function of a Credit Default Swap (CDS)?
What is the primary function of a Credit Default Swap (CDS)?
- To increase the overall yield of a bond
- To insure against changes in market interest rates
- To provide liquidity to bondholders
- To protect against the risk of bond issuer default (correct)
What is a characteristic of government bonds?
What is a characteristic of government bonds?
Which of the following accurately describes the relationship between gross and net price of a bond?
Which of the following accurately describes the relationship between gross and net price of a bond?
What distinguishes private debt from public debt?
What distinguishes private debt from public debt?
What is a potential consequence for a firm if it fails to make promised payments on its bonds?
What is a potential consequence for a firm if it fails to make promised payments on its bonds?
Why do larger firms often rely on the bond market for financing?
Why do larger firms often rely on the bond market for financing?
Which of the following features does NOT describe a bond?
Which of the following features does NOT describe a bond?
What happens to a firm’s assets after it issues bonds?
What happens to a firm’s assets after it issues bonds?
What is the function of the coupon in a bond?
What is the function of the coupon in a bond?
How does a firm benefit from issuing bonds for funding new equipment?
How does a firm benefit from issuing bonds for funding new equipment?
What is par value in relation to a bond?
What is par value in relation to a bond?
What type of coupon bond does not provide any interest payments?
What type of coupon bond does not provide any interest payments?
Which statement is true regarding an undervalued bond?
Which statement is true regarding an undervalued bond?
What is the relationship between a bond's coupon rate and the expected return for a premium bond?
What is the relationship between a bond's coupon rate and the expected return for a premium bond?
What does a bond rating of 'CCC' indicate?
What does a bond rating of 'CCC' indicate?
If a bond's market price is equal to its intrinsic value, what type of bond is it considered?
If a bond's market price is equal to its intrinsic value, what type of bond is it considered?
Which of the following represents the least creditworthy bond rating?
Which of the following represents the least creditworthy bond rating?
How is the expected return on a bond generally calculated?
How is the expected return on a bond generally calculated?
What characteristic defines a floating coupon rate bond?
What characteristic defines a floating coupon rate bond?
Flashcards
Corporate Bond
Corporate Bond
A debt security issued by a corporation promising future payments and a maturity date.
Public Debt
Public Debt
Debt that can be traded in public financial markets, like bonds.
Face Value (Par Value)
Face Value (Par Value)
The principal amount of a loan that must be repaid to the bondholder at maturity.
Coupon (Bond)
Coupon (Bond)
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Bond Issuance
Bond Issuance
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Bond Maturity
Bond Maturity
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Bond Bankruptcy
Bond Bankruptcy
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Bond Market
Bond Market
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Bond Coupon
Bond Coupon
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Zero-Coupon Bond
Zero-Coupon Bond
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Bond Market Price vs Intrinsic Value
Bond Market Price vs Intrinsic Value
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Undervalued Bond
Undervalued Bond
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Overvalued Bond
Overvalued Bond
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Bond Rating
Bond Rating
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Bond Discount
Bond Discount
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Expected Return
Expected Return
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Negative Bond Yields
Negative Bond Yields
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Bond Market Risk
Bond Market Risk
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Liquidity Risk
Liquidity Risk
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Default Risk
Default Risk
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Credit Default Swap (CDS)
Credit Default Swap (CDS)
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Study Notes
Introduction to Bonds
- Bonds are a crucial source of borrowing for corporations, often seen as public debt due to trading in financial markets.
- Smaller firms favor loans from banks due to higher costs associated with issuing bonds.
- Larger firms predominantly use bond markets for long-term financing.
- Corporations also raise funds by selling debt securities to individual investors and financial institutions like mutual funds.
- Issuing firms must meet legal requirements set by securities laws.
Definition of Bonds
- A corporate bond is a debt security promising future payments with a maturity date.
- Failure to fulfill promised payments (interest and principal) can lead to the firm being classified as insolvent and forced into bankruptcy.
- Bonds are an important part of external debt financing.
Impact of Bond Issuance
- Issuing bonds increases cash holdings and debt on a corporation's balance sheets.
- Equity remains unchanged.
- Bond issuance is often used to finance new equipment.
Bond Features
- Face value (par value): The principal amount repaid to bondholders at maturity.
- Coupon: Regular interest payments throughout the bond's life.
- Types of coupons
- Zero-coupon: No interest payments, payout at maturity.
- Fixed coupon rate: Pre-determined interest payments.
- Floating coupon rate: Interest changes based on a pre-set benchmark (e.g., inflation, base rate, LIBOR).
- Maturity: The date when the principal is due to be repaid.
- Intrinsic value: Present value of future cash flows (interest and principal), calculated using a risk-adjusted interest rate.
- Market value: The price at which bonds trade in secondary markets.
- Undervalued and overvalued bonds: Classification depending on whether the market value is lower or higher than the intrinsic value.
- Bond rating: A measure of a bond's riskiness, assigned by rating agencies (Moody's, Standard & Poor's, Fitch), influencing expected return and risk premium.
- Bond rating (example codes):
- AAA: Best creditworthiness.
- BBB: Good creditworthiness but recession risks could be a concern.
- CCC: Defaul risk is likely.
- D: Actual default or delay of payment .
Bond Pricing
- Gross price includes accrued interest since the last coupon payment.
- Net price is the actual price paid after considering accrued interest.
Types of Bonds
- Discount bonds: Trade below par value with lower coupon rates than expected returns.
- Premium bonds: Trade above par value with higher coupon rates than expected returns.
- Par bonds: Trade at par value with coupon rates equal to expected returns.
Market Price vs Intrinsic Value
- Intrinsic value represents the present worth of future cash flows from the bond, calculated with a risk-appropriate interest rate.
- The market price is the current price at which bonds are traded on secondary markets.
Bond Risks
- Market risk: Interest rate changes impact bond prices.
- Liquidity risk: Difficulty in selling bonds without incurring significant losses.
- Default risk: Risk that the bond issuer may not be able to pay back the bond.
Credit Default Swaps (CDS)
- A CDS is a contract where a buyer pays a premium to an insurance provider (seller).
- If the issuer defaults, the seller pays the bondholder.
- Used mainly for government bonds to reduce risk of default.
Government Bonds
- Issued by governments.
- Used to finance budget deficits.
- Bondholders lend money to the government.
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