1
Q
What is a bond summary?
A
a DEBT INSTRUMENT (AKA Fixed Interest Security) whereby an investor lends money to an entity (such as a company or a government) that borrows the funds for a defined period of time at a fixed interest rate
2
Q
Who are the 2 major issuers of bonds?
A
Companies (large listed plcs)
Governments
3
Q
What type of bonds do companies issue?
A
issuing CORPORATE BONDS
4
Q
What type of bonds do governments issue?
A
issuing GOVERNMENT BONDS
5
Q
Are longer dated bonds more risky?
A
Yes
e.g. Microsoft is probably more likely to have problems in the next 30 years rather than the next 5 years
6
Q
Give 3 reasons companies would rather make bonds issues over borrowing from a bank?
A
Cheaper
Greater control & Freedom
More achievable
7
Q
Explain why companies would rather make bonds issues rather than borrowing from a bank?
A
Companies can borrow at lower rates of interest compared with borrowing from a bank
Companies can make multiple bond issues for different amounts, different lengths of time to repay and different interest rates
Companies do not have to meet a banks’ requirement e.g. restrictions on borrowing from other sources
Companies can borrow very large sums of money - banks may be reluctant to take on that much risk
8
Q
What is a stock name?
A
Name of the bond
Normally issuer name
9
Q
What is a coupon?
A
Annual rate of interest is quoted gross (before the deduction of any tax)
Interest calculated on the NOMINAL value
UK gilts are normally paid in two separate and equal half-yearly interest payments made 6 months apart
10
Q
What is a market price?
A
Bond Prices are quotes by how much it is to buy 100GBP nominal of the bond
When issued the pice is 100GBP to buy 100GBP nominal of the bond - this can change if a bond is traded before maturity
11
Q
What is the nominal/par/face value?
A
The amount of stock purchased
Not necessarily the same as the bond price
The amount on which interest will be paid
The amount that will eventually be repaid at maturity
12
Q
What is the redemption/maturity date?
A
The year in which the nominal amount will be repaid
Repayment will take place at the same time as the final interest payment is made
The amount repaid will be the nominal amount of stock held
13
Q
Explain the UK government bond issue of January 2015?
A
The UK government sold 1.75 BILLION of bonds called TREASURY GILTS in January 2015
The bond will repay the borrowed money in 2034 and will pay interest of 4.5% each year
14
Q
What are UK government bonds known as?
A
GILTS - as the first certificates had a gold edge
15
Q
What are bonds essentially?
A
IOUs
16
Q
What is the clear reason for issuing bonds?
A
Clearly, the reason for issuing bonds is for the issuer to raise finance, perhaps to fund something in particular
17
Q
Is it increasingly common to see bonds issued to fund activities that are environmentally responsible and if so what are these bonds referred to as?
A
Yes
green bonds
18
Q
What does the subset of green bonds do and what are they called?
A
they aim to conserve oceans
blue bonds
19
Q
Why may green or blue bonds be more attractive to investors?
A
The fact that bonds are a form of responsible investing it might make them more attractive to investors and, therefore, make the cost to the issuer a little less
20
Q
What is 1 of the 3 major ways for a company to raise finance?
A
BONDS
the alternatives are bank loans and equity issues
21
Q
Can companies choose to issue bonds with different dates of repayment?
A
Yes
the repayment dates chosen will depend on a number of factors, including the financial plans of the issuing company and the periods over which investors may wish to invest
22
Q
What 2 features do all bonds tend to exhibit?
A
particularly a date when the bond will repay the money loaned
the frequencies at which the interest payments will be made
23
Q
Are bonds not tradeable instruments and if so/not what does this mean?
A
NO - bonds are tradeable instruments
This means that they can be bought and sold
24
Q
Can bonds be bought or sold?
A
Yes
25
Give 3 key features about bonds?
Tradeable
Repayment date
Interest rate and Frequency
26
What is the nominal value?
the NOMINAL VALUE of a bond is the amount that is owed by the bond issuer, and that will be repaid on the repayment date
27
What else may the nominal value be referred to as?
PAR value
FACE value - *because it is the amount that is written on the face of the bond certificate - the IOU*
28
What 2 things is the repayment date usually referred to as?
REDEMPTION DATE or MATURITY DATE
*so commentators will talk about bonds redeeming in perhaps five years’ time, or maturing in five years’ time*
29
Is the interest rate that is applied to the nominal value more typically termed the coupon on the bond?
Yes
30
What is ‘yield’ another word for?
YIELD is another word for return
31
What is yield expressed as?
an annual percentage
32
In what case is the bond yield the same as the coupon?
this is only the case if the bond is being bought and sold at its nominal value
33
What will happen to the bond yield if the traded price rises above or falls below the nominal value?
the yield will be different from the coupon, because to calculate the yield you divide the annual coupon by the price paid
34
Explain what a flat yield is caused by?
When the yield calculation includes only the calculation of couple divided by price, it is called the flat yield
35
Explain yield to maturity?
If the buyer keeps the bond until its maturity date, the yield will also be supplemented by the fact that the buyer will make a gain when the bond matures and repays 1000GBP, because they only paid 800GBP for it
When the calculation includes the capital gain (or loss) if the bond is held until its maturity date, it is called the yield to maturity
36
What kind of relationship does bond yield and bond prices have?
INVERSE relationship
37
What can the relationship between bond prices and bond yields be compared to?
a see-saw
38
Are bond prices susceptible to movements in general interest rates and if so why?
YES - because for their yield to be attractive to an investor it needs to remain competitive with the return available on alternative investments
39
What is the nominal value?
the original amount of the bond purchased with this amount paid back to the bond holder at the redemption date
coupons are calculated on this value
40
What is a coupon?
the interest rate paid to the bond holder every year or half-yearly
coupons are calculated on the nominal value of the bond
41
What is the redemption date?
the date which a bond matures and pays back the nominal value to the bond holder
can be 5, 10, 15 years or more after the bond is issued
42
What is a stock name?
the name of the bond which usually includes the name of the issuer, the coupon rate and maturity date
43
What are gilts?
the name given to UK government bonds
this was due to a gold-edged certificate issued
44
What is a bond price shown as?
the amount it costs to purchase 100GBP nominal of the bond
e.g. when a 5-year 10,000GBP nominal bond is initially purchased, the price is 100GBP to buy 100GBP nominal of the bond (100GBP X 100GBP = 10,000GBP nominal value)
45
Is the bond holder allowed to sell the bond before it matures?
Yes
46
What should you know about trading and bonds?
*bonds can be traded between investors via an exchange before a bond matures*
The amount the new bond holder pays for the bond (its price), may not be the same as the nominal value i.e. they may pay more or less than 100GBP for 100GBP nominal of that bond
47
What kind of releationships is there between interest rates and bond price when bonds are traded?
INVERSE relationship
48
What should you remember about interests rates and bond price?
If the interest rates GO DOWN, bond price INCREASES (above 100GBP per 100GBP nominal)
If the interest rates GO UP, bond price DECREASED (below 100GBP per 100GBP nominal)
49
Is it true that there is an inverse relationship between interest rates and bond price when bonds are traded?
Yes
50
Why do bond prices respond to changes interest rates?
This is because, for their yield (return) to be attractive to investors it must remain competitive (when compared to the return available on alternative investment instruments)
If the bank increases the rate of interest, then alternative investments may appear to have a more competitive return
In response to this the bond price decreases to make the bond appear cheaper to purchase, and the yield offered needs to increase
51
What is a coupon?
this is the INTEREST RATE paid on the FACE / NOMINAL value of the bond
52
Are yield and coupon the same thing?
NO
53
When only is yield and coupon the same?
they are only the same when the bond is bought/sold at its FACE/NOMINAL value
*otherwise, generally they are different*
54
What is a yield?
this is just another word for ‘return’ and it is expressed as an ANNUAL PERCENTAGE
55
Explain what happens if an investor trades a bond before maturity?
If an investor trades a bond before maturity, the new buyer may not have paid the par / nominal value for the bond appear- they may have paid a different amount to purchase the bond, so a method of calculating the TRUE RETURN to him or her is needed
*this is when the coupon rate and yield will be different*
56
What is a flat yield?
the most straightforward yield is to look at the coupon paid on a bond as a percentage of its market price - known as the FLAT or RUNNING YIELD
57
What is the equation for flat yield?
Flat Yield (%) = (Annual Coupon (GBP) / Bond Market Price (price paid to purchase 100GBP nominal) ) x 100
58
What kind of relationship is there between bond prices and bond yields when a bond is traded?
INVERSE relationship
59
What must you remember about bond prices and yield?
If the bond price DECREASES, yield INCREASES (above the coupon %)
If the bond price INCREASES, yield DECREASES (below the coupon %)
60
Is there an inverse relationship between bond prices and bond yield when bonds are traded?
YES
61
What are bond prices susceptible to?
bond prices are SUSCEPTIBLE to movements in general interest rates
62
What does the yield need to remain as to be attractive?
For the yield offered to be attractive to investors it needs to remain competitive with the return available on alternative instruments
63
What happens when an individual doesn’t pay their mortgage?
The lenders makes sure that it has the ability to repossess the property if the scheduled mortgage payments are not made
The same principles applies with corporate bonds - *this is known as SECURITY*
64
Explain bond security?
Security refers to the guarantee provided to the investors that the bond will be repaid
Security usually means a legal charge over some or all of the bond issuer’s assets e.g. properties (offices and factories), unsold goods or uncollected debts
If the issuer fails to pay the required coupons or the principle al on the bonds, the bond holder can claim those assets in order to recoup the money that is owed to them
Bond holders regard their borrowings as safer than if there were no security
65
What are the 3 different types of security?
Fixed Charge
Floating Charge
Third Party Guarantee
66
What is the fixed charge type of security?
a SPECIFIC ASSET, such as the head office of the company, or a particular factory, provides the security for the loan
67
What is the floating charge type of security?
GENERAL ASSETS of the company are offered as security for the loan, which might include the company’s cash at the bank, trade debtors and unsold stock
68
What is the third party guarantee type of security?
a GUARANTEE from another organisation or individuals that if the issuer defaults, they will repay the bondholder e.g. a bank
69
What do credit rating agencies look at?
CREDIT RATING AGENCIES will book issuers and assess the risk involved
*some corporate and most government bonds*
70
What are the 3 dominant credit rating agencies?
Moody’s
Standard & Poor’s (S&P)
Fitch Ratings
71
Does Standard & Poor’s (S&P) and Fitch Ratings use an identical scale?
Yes
72
Does Moody’s use their own scale compared to Standard & Poor’s and Fitch Ratings?
Yes
73
What are issue3rs with the LEAST credit risk termed as?
Triple A (AAA)
74
What kind of system do the 3 dominant credit rating agencies use to term their issuers in terms of credit risk?
ALPHABETICAL system
75
From where up on Moody’s ratings is the investment grade considered LESS CREDIT RISK?
Baa *and above*
76
From where up on Standard & Poor’s / Fitch Ratings ratings is the investment grade considered LESS CREDIT RISK?
BBB *and above*
77
From where down on Standard & Poor’s / Fitch Ratings ratings is the non-investment grade considered MORE CREDIT RISK?
Ba *and below*
78
From where down on Moody’s ratings is the non-investment grade considered MORE CREDIT RISK?
BB *and below*
79
Give 4 advantages of bonds for investors?
A regular and certain flow of income (bonds with a fixed coupon)
For many bonds (not all!) they have a fixed maturity date
A range of income yields to suit different investment and tax situations
Relative security of capital for more highly rated bonds
80
Give/explain some disadvantages and risks of bonds for investors?
PRICE RISK / MARKET RISK - fluctuations in intertes rates cause bond prices to change accordingly when they are traded
DEFAULT RISK - there is a possibility that the issuer will not be able to pay the coupon or capital back
SENIORITY RISK - some bonds may rank behind more recently issued bonds in terms of being repaid if the issuer is unable to pay the bond back (company may go into liquidation)
EXCHANGE RATE RISK - bonds denominated in a currency different from that of the investor’s home currency are potentially subject to adverse exchange rate movements
LIQUIDITY RISK - the ease with which a security can be converted into cash ~ some bonds are more easily sold at a fair market price than others
INFLATION RISK - if inflation rises, the ‘real’ value of the bond’s coupon and redemption payment are eroded
81
Give some key features of coupons in the bonds topic?
Interest payments made to bond holders in return for lending money to issuer :
-normally fixed ~ more certainty
-paid half-yearly
-based on % of nominal amount
-return can be calculated by bond yield
82
What is trading a bond for more than the purchase price before it matures dependent on?
dependent on prevailing interest rates
83
Give some key features of dividends in the equities (shares) topic?
Payments made to shareholders from company profits (determined by Board of Directors) :
-varies ~ less certainty
-paid once or twice-a-year
-may not be paid at all
-return can be calculated by dividend yield
84
Give 2 points on capital gains?
Share price increases above the purchase price
Sold to make a profit
85
Give some points on bonds?
-less risk than shares
-investors turn to bonds during uncertain economic times
-security provides greater certainty, as does a fixed return
-potential returns are not as high as shares but less risk
-pension funds invest heavily in bonds
-bondholders first to receive money when company fails
86
Give some points on equities?
-share prices are volatile ~ increases risk and potential reward
-variable returns ~ dividends are not fixed
-shareholders last to receive money when company fails
-issuing new shares not popular with existing shareholders ~ dilutes shareholding
87
Why is it better for your business to issue bonds rather than equity?
Issuing equity means that the influence of the original shareholders will become diluted
e.g. A company doubles its shares by selling new shares to new shareholders. This means the original shareholders’ original 100% ownership will be diluted to just 50% after the new issue.
Hence, this is not a popular choice for existing shareholders
88
What is leverage?
LEVERAGE is the proportion of debt finance compared to equity finance in a company
89
What 2 things will a business raise finance through?
DEBT or EQUITY
90
What are the 2 particular features that provide key advantages of investing in bonds?
COUPONS and the REDEMPTION DATE
91
For investors is a predictable income seen as an advantage?
Yes
92
In what form do most bonds pay a states amount of income every year or half-year?
COUPONS
93
Is it true that the amount of dividend paid to investors is unpredictable?
Yes
94
Explain a potential disadvantage of investing in bonds?
the potential disadvantage of investing in bonds is the possibility that the issuer will fail to pay some or all of the coupons and the redemption amount because it does not have the available funds
95
What is the bond issuer described as when they fail to pay some or all of the coupons and the redemption amount because it does not have the available funds?
the issuer is described as being in *default*
96
What are less substantial issuers more like to be than other more substantial issuers?
DEFAULT
97
What can have an adverse impact on the return for an investor?
However, rather than a complete default, just an increased possibility of default can have an adverse impact on the return for an investor
*this will be the case if the investor has to sell the bond before it reaches maturity*
98
What is ‘a bond being sold before maturity and the risk that the issuer will default increasing’ alternatively described as?
this is alternatively described as an increase in the CREDIT RISK of the issuer ~ the risk that the amount owing (the credit) may not be repaid
99
Give the 2 key advantages of investing in bonds that you should remember?
Predictable income in the form of regular, fixed coupons
Fixed date and amount to be repaid at redemption
100
Give the 2 key disadvantages of investing in bonds?
Actual default - the failure of the issuer to be able to pay the coupons and/or the redemption amount
An increased risk of default resulting in a fall in the bond’s value
101
What do credit rating agencies do?
look at bond issuers and assess the credit risk
102
What are the 3 dominant credit rating agencies globally?
Moody’s
Standard & Poor’s (S&P)
Fitch Ratings
103
What are issuers rated triple A (AAA) by Standard & Poor’s and Fitch Ratings described as having?
described as having an *extremely high capacity to meet their financial commitments*
in other words, they are likely to be able to pay the bonds’ coupons and repay the nominal value at maturity
104
What does Moody’s Aaa describe?
Moody’s describes Aaa as reflecting issuers of the *highest quality with minimal credit risk*
essentially saying the same thing as the two other agencies
105
What is the lowest rating from Moody’s credit risk scale?
C
106
What is the lowest credit risk rating from S&P and Fitch Ratings?
D
107
What is the 2 broad choices of a company wanting to raise finance?
to raise money by borrowing (in the forms of bonds or bank loans)
to raise money by selling more equity
108
What exactly is leverage?
LEVERAGE is the proportion of debt finance compared to equity finance in the company
109
Explain the impact of leverage?
The impact of leverage is that when a company performs well, it appears that the larger the proportion of the financing that comes from debt, the better
The larger the leverage, the more the gain to the shareholders is magnified
110
What are the 2 particular things that have an impact on how much borrowing companies have?
1) How much lenders are willing to lend, and how much they charge for that lending
2) The fact that, if the company does not perform well, a larger proportion of borrowing will have the opposite effect on the equity value
111
Will providers of debt finance consider the risks they face when making their loans and if so why?
Yes
simplistically, the more a company borrows, the greater the risks
as a result, the proportion of debt cannot go beyond the level that presents too large a risk for the lenders to be willing to lend
*Furthermore, as the proportion of debt increases, the credit rating assessment will fall, which will make the borrowing more expensive, perhaps prohibitively so*
112
In summary what is financial leverage?
In summary, financial leverage is the proportion of a debt relative to the equity within a business
The greater the proportion of debt, the more gains in the business are magnified to the shareholders
However, the greater the proportion of debt, the more losses are magnified to the shareholders
