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ECON 2560 Chapter Notes - Chapter 6: Accrued Interest, Current Yield, Corporate Bond

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School
University of Guelph
Department
Economics
Course
ECON 2560
Professor
Nancy Bower

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Document Summary

A bond is a debt security, under which the issuer (government or companies) owes the holders (investors) a debt, and is obligated to pay them interest (coupon) and to repay when the maturity level expires. Face value: payment due at the bond"s maturity. Maturity: the date at which the loan will be paid off (when you will get your interest payment) Example: telus bond has a fixed coupon payment, based on its 5. 05 percent coupon rate, and the bond will mature in july 2020. Telus has to make coupon payments for 10 years and then has to repay the billion face value. Dividend: your return of the money you invested in stock: it is your payout from stock shares. Interest rate (discount rate): the rate at which the cash flows from the bond are discounted to determine its present value. The coupon rate and the discount rate are not necessarily the same!

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Related Questions

The United States territory of Puerto Rico was effectively downgraded to non-investment grade on February 4, 2014 by Standard & Poor’s when it downgraded Puerto Rico’s general obligation debt from BBB- status to BB+, on level below investment grade. Moody’s and Fitch Ratings quickly followed and within a matter of 10 days all three ratings agencies had downgraded Puerto Rico’s debt.

Each of these downgrades triggered several covenants, or acceleration clauses, which forced Puerto Rico to repay certain debt instruments within months rather than years. Also resulting from the downgrades was an increase in Puerto Rico’s cost of capital. Unlike a corporation, municipalities such as cities, states, and territories are 100% debt financed. Thus, a drop in credit rating to junk bond status requires Puerto Rico to offer investors a higher rate of interest on new debt issues and will reduce the market value of existing bonds. Therefore, improving the situation by restructuring existing bonds and issuing new bonds becomes an extremely difficult task. While municipal financing differs from corporate financing, the prescription for lowering the cost of borrowing is similar for both: increase revenues and/or cut costs. Puerto Rico currently states that it is unable to maintain its current operations unless it takes drastic measures that may lead to civil unrest. This includes cutting payments to government pensioners and slashing health care funding. There have already been protests over the austerity measures.

The devastation caused by Hurricane Irma (and now potentially Hurricane Maria) is likely to worsen the situation as previously allocated municipal funds will need to be diverted for the relief effort. If you were tasked with proposing a solution to the situation, which must address the rising cost of capital, how would you approach the issue?