FNBU 3221 Chapter Notes - Chapter 7: Interest Rate Risk, Unsecured Debt, Credit Risk

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26 Mar 2017
Department
Course
Professor
Chapter 7
Bonds and Bonds Valuation
Bond features & prices
o Coupon: stated interest payment made on bond
o Face (par) value: principal amount of bond that is repaid @ end of term
o Coupon rate: annual coupon divided by face value of bond
o Maturity: specified date on which principal amount of bond is paid
Bond values & yields
o Yield to maturity (YTM): rate required in market on bond
o Bond prices & interest rates have inverse relationship
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Interest rate risk
o Longer time to maturity, greater interest rate risk
o Lower coupon rate, greater interest rate risk
Finding the yield to maturity: more trial & error
o Yield to maturity ≠ current yield
o Current yield: bond’s annual coupon divided by its price
More about Bond Features
Long-term debt: the basics
o Debt securities can be short-term (maturities of 1 year/less)/long-term (maturities of
1+ years)
Short-term debt aka unfunded debt
o 2 major forms: public-issue & privately placed
The indenture
o Indenture: written agreement between corporation & lender detailing terms of debt
issue
Terms of a bond
Registered form: form of bond issue in which registrar of company
records ownership of each bond; payment made directly to owner of
record
Interest payable semiannually on July 1 & January 1 of each year to
person in whose name bond is registered @ close of business on June
15/December 15, respectively
Bearer form: form of bond issue in which bond is issued w/out record
of owner’s name; payment made to whomever holds bond
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o 2 cons: difficult to recover if lost/stolen & can’t notify
bondholders of important events b/c company doesn’t know
who owns its bonds
Security
Collateralsecurities pledged as security for payment of debt
Mortgage securitiessecured by mortgage on real property of
borrower
Blanket mortgagepledges all real property owned by company
Debenture: unsecured debt, usually w/ maturity of 10+ years
Note: unsecured debt, usually w/ maturity under 10 years
Seniority
Senioritypreference in position over other lenders
Repayment
Sinking fund: account managed by bond trustee for early bond
redemption
o Company makes annual payments to trustee, who then uses
funds to retire portion of debt (trustee does this by either
buying up some of bonds in market/calling in fration of
outstanding bonds)
The call provision
Call provision: agreement giving corporation option to repurchase
bond @ specified price prior to maturity
Call premium: amount by which call price exceeds par value of bond
Deferred call provision: call provision prohibiting company from
redeeming bond prior to certain date
Call protected bond: bond that, during certain period, cannot be
redeemed by issuer
Protective covenants
Protective covenant: part of indenture limiting certain actions that
might be taken during term of loan, usually to protect lender’s interest
o 2 types: negative (limits/prohibits actions company might take)
& positive (specifies action company agrees to take/condition
company must abide by)
Bond Ratings
Debt ratingsassessment of creditworthiness (how likely firm is to default & protection
creditors have in event of default) of corporate issuer
Bond’s credit rating can change as issuer’s financial strength improves/worsens
Some Different Types of Bonds
Government bonds
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Document Summary

Bonds and bonds valuation: bond features & prices. + (cid:4666)1+(cid:4667: (cid:1829)=(cid:1829)(cid:1867)(cid:1873)(cid:1868)(cid:1867)(cid:1866) (cid:1868)(cid:1853)(cid:1856) (cid:1857)(cid:1853)(cid:1855) (cid:1868)(cid:1857)(cid:1870)(cid:1867)(cid:1856, (cid:1870)=(cid:1853)(cid:1872)(cid:1857) (cid:1868)(cid:1857)(cid:1870) (cid:1868)(cid:1857)(cid:1870)(cid:1867)(cid:1856, (cid:1872)=(cid:1873)(cid:1865)(cid:1854)(cid:1857)(cid:1870) (cid:1867)(cid:1858) (cid:1868)(cid:1857)(cid:1870)(cid:1867)(cid:1856)(cid:1871, =(cid:1828)(cid:1867)(cid:1866)(cid:1856) (cid:1871) (cid:1858)(cid:1853)(cid:1855)(cid:1857) (cid:1874)(cid:1853)(cid:1864)(cid:1873)(cid:1857, longer time to maturity, greater interest rate risk, lower coupon rate, greater interest rate risk. Interest rate risk: finding the yield to maturity: more trial & error, yield to maturity current yield, current yield: bond"s annual coupon divided by its price. More about bond features: long-term debt: the basics, debt securities can be short-term (maturities of 1 year/less)/long-term (maturities of. Interest payable semiannually on july 1 & january 1 of each year to person in whose name bond is registered @ close of business on june. & positive (specifies action company agrees to take/condition company must abide by) Bond ratings: debt ratings assessment of creditworthiness (how likely firm is to default & protection creditors have in event of default) of corporate issuer, bond"s credit rating can change as issuer"s financial strength improves/worsens.

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