Amortized loan vs Discount loan
A - series of payments. Loan for PV is to be repaid in n equal payments each period at interest rate
D - no series of payments. Borrower receives loan’s face value minus interest charged up front
Interest only loans
Equal periodic payments covering only interest, and then a single balloon payment of the full principal at maturity
What is a bond
Legally binding agreement between a borrower and lender.
Long-term debt security issued by a corporation or government.
Main bond features (coupon, face/par value, coupon rate, maturity)
Coupon - stated interest payment made
Face value or par value - amount repaid at the end of the loan
Coupon rate - annual coupon/fv ; basically interest rate
Maturity - # years until fv is paid
Municipal vs Corporate bond
M - issued by a municipality
C - issued by a corporation
3 types of bonds issued by the government
if maturity > 10yrs, 2 coupons a year -> treasury bond
if 1 < maturity < 10yrs -> treasury notes
if maturity < 1yr -> treasury bills (zero coupon bonds, risk free)
Secured vs Unsecured Bonds
S - collateral; house or machines; assets can be seized.
U - no collateral; they pledge their profit stream; riskier
Term Bond and Serial Bond
T - has only 1 specific maturity date
S - multiple maturity dates
Callable Bond (call provision)
Can be called back anytime, immediate upon being called.
Call provision - allows issuer to repurchase bonds before maturity
Bond Covertibility
If it can be converted to other types of security, like stock
Zero-Interest Bond
Only payment at maturity (principal + interest), no periodic interest payments
Registered vs Bearer Bonds
Registered on someone’s name.
Bearer has no name.
- no record of who owns the security at any point in time, so physical possession of the security is the only evidence of ownership
Commodity Backed Bonds
Repaid with commodities (gold, oil…)
Floating rate bond
Adjustable coupon tied to short-term rates.
Income Bond
Pays interest only if income is sufficient
Cat Bond
Covers natural disasters
Relationship between interest rates and PV or bond’s price
As interest rates increase, the PV and bond price decrease.
Interest rates and bond prices move in opposite directions
What does a bond’s YTM show
The market interest rate required on a bond. Also called bond’s yield
How much an investor’s money will earn if it’s held until it matures
Discount Bond vs Premium Bond
If YTM = coupon rate, then par value = bond price.
Discount
If YTM > coupon rate, then par value > bond price
Premium
If YTM < coupon rate, then par value < bond price
2 things that determine how sensitive a bond will be to interest rate risk
- time to maturity - the longer the time to maturity, the greater the risk
- coupon rate - the lower the coupon rate, the greater the risk
Does a bond’s coupon rate change
NO, interest rates fluctuate, but coupon rate on the bond never changes
What is the bond indenture and what it includes
Contract between the company and the bondholder.
- basic terms of the bond
- total amount of bonds issued
- description of property used as security
- sinking funds provision
- call provisions
- details of protective covenants
4 types of security
- collateral - secured by financial securities
- mortgage - secured by real property
- debentures - unsecured debt w original maturity of 10+ years
- notes - unsecured debt w original maturity of less than 10 years
Sinking Fund
Account managed by the bond trustee for early bond redemption.
Account for early bond repayment, reduces default risk.
