# bond prices – Flashcards

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bond prices and interest rates are inversely related.
The interest rate on the bond (or the yield to maturity) is the discount rate. As the discount rate gets larger, the price of the bond will decrease.
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As the coupon rate increases, the bond price will increase.
Bond prices are calculated by taking the present value of the coupons and face value of bonds. If the coupons are larger, the present value of the coupons will also be larger. Therefore, price of the bond will be higher.
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A 20-year bond with a \$1,000 face value has a coupon rate of 8.5% but pays coupons semiannually. The yield to maturity for the bond is 9.5%. Given this information, first coupon that will be paid will be \$42.50.
The first semiannual coupon will be (.085 x \$1,000) / 2 = \$42.50.
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A bond with a coupon rate that is less than the yield to maturity will be priced at a discount.
If the coupon rate is less than the yield to maturity, the bond must be priced at a discount.
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If the coupon rate is equal to the yield to maturity, the bond will be priced at par or face value.
A bond with a face value of \$1,000 will have a current price of \$1,000 if the coupon rate is equal to the yield to maturity.
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Debentures are unsecured bonds.
There is no specific collateral associated with these bonds. Instead, they are a sort of corporate "IOU" backed only by the full faith and credit of the company. Because these types of bonds are not secured with collateral, they are risky.
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subordinated debentures are bonds that are not backed by any specific collateral.
subordinated debentures have a lower claim than normal debentures to the assets of the firm in the event of firm liquidation.
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mortgage bond is a bond that has specific collateral, such as a piece of real estate, behind it.
mortgage (which is a form of a loan) specifies that in the event that the individual who owns the mortgage files for bankruptcy, the home goes directly to the issuer of the mortgage. None of the other creditors of that individual can try to claim part of the house to cover their losses; it was already promised as collateral to the mortgage issuer.
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zero coupon bonds, zeros pay no coupon payments—their coupon rate is 0%.
They typically sell at deep discounts. For example, a \$1,000 par value bond maturing in 10 years may sell for \$500 today. Because they pay no interest during the life of the bond, all of the investor's return has to come from capital gains (par value minus purchase price).
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junk bonds. Bonds with a rating of BB or below.
They are seen as too risky to be considered investment grade.
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Eurobond is payable in a currency not native to the country in which it is issued.
American bond issued in Europe, that is payable in dollars, is a specific type of Eurobond called a Eurodollar bond.
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Foreign Bonds are issued in a domestic market by a foreign firm, but in the domestic currency.
a Chinese firm floats debt in the US and the debt is payable in dollars, then China has floated a foreign bond.
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Munis, short for municipal bonds, are floated by local governments (states, cities, counties) to usually fund infrastructure improvements, such as new roads or government buildings.
Munis are almost always exempt from federal taxation, which makes them attractive investments for investors in high tax brackets.
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Treasuries are bonds issued by the US federal government to support deficit spending.
Treasuries range from short-term, 3-month T-bills to long-term, 30-year T-bonds. Because treasuries are backed by the full faith/allegiance and, more importantly, the taxing power of the US federal government, treasuries are often used as risk-free investment vehicles in financial models.
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Convertible Bonds
Convertibility refers to the ability to convert a bond into equity securities, usually common stock. It gives the investor the right to trade each bond for a set number of shares of common stock whenever the investor chooses. The conversion rate (or number of shares of stock per bond) is contractually set at the bond issue and is listed in the bond indenture.
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yield to maturity -YTM
required rate of return or cost of capital for a bond—it is the average annual rate of return that investors expect to receive on a bond if they hold it to maturity. also known as the promised yield, meaning that it is the return we are promised if we buy a bond today and hold it to maturity.
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current yield to maturity -Current Yeild
"current yield to maturity." is yield measure calculated by dividing the annual coupon payment by the current price of the bond. It is an estimate of the YTM, but it ignores the time value of money.
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If coupon rate = discount rate, the bond will sell for par value.
If coupon rate = discount rate, the bond will sell for par value.
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If coupon rate > discount rate, the bond will sell for a premium.