SIE 4/5 - Debt Instruments

  1. What is par value? What is par?
    • $1,000
    • The amount the issuer agrees to pay investors at maturity, it is the face value of the bond
  2. What's a debenture? What's the standard number?
    • It is the interest/coupon rate as a fixex % of par
    • It is set when the bond is issued, but paid semi-annually.
    • Assume 10% (i.e. 5% every 6 months)
  3. When is the last interest payment made on a bond?
    Due date
  4. Debenture vs secured bonds
    • Debenture = no collateral needed
    • Secured = collateral needed
  5. How do zero-coupon bonds differ? What is the risk and suitability?
    • They are issued at a deep discount, mature at par, and the interest is the difference between the purchase price and par value. The carrying value is the investor's cost basis, so it appreciates over the life of the bond.
    • They trade flat (without accrued interest). They're not subject to reinvestment risk.
    • They're most suitable for investors planning for a specific future investment goal (i.e. need growth with <10 years until the goal)
  6. What are the two factors that can cause bond prices to fluctuate from par? How does each impact bond prices?
    • Interest rate: as market interest rate goes up, bonds go down
    • Credit risk: as a borrower's credit goes up, bonds go up
  7. What are the lowest bond ratings that are investment grade and the highest levels that are speculative grade? State both S&P and Moody's rankings.
    • Lowest: BBB or Baa
    • Highest BB or Ba
  8. Explain the ticks of corporate/muni bonds and federal bonds.
    • Corporate/muni: tick is 1/8 = 0.125
    • Federal: tick is 1/32 = 0.03125
    • A bond that is worth 93 5/8 is 93.625% of par or $936.25
  9. What are bond call and put provisions?
    • Call provisions allow the issuer to redeem bonds prior to maturity . The investor will receive the full return of principal plus any accrued interest. This is done when interest rates are falling. Sometimes they have call protection (time when they cannot be called) and there is usually a premium above par. They are also higher yield.
    • Put provisions allow the bondholder the right to redeem the bond prior to maturity. This is very uncommon but it would be used when interest rates are rising.
  10. What is a convertible bond?
    • It allows the investor to convert the par value of the bond into a predetermined number of shares of common stock.
    • The issuer generally pays a lower coupon rate.
    • Price is influenced by underlying price.
  11. Explain conversion ratio.
    • For a convertible bond, conversion ratio = the number of shares the investor will receive at conversion
    • Conversion Ratio = Par Value/Conversion Price
    • Conversion price is set when the bond is issued.
  12. What risks is a convertible bond subject to?
    • Credit (normal)
    • Interest (normal)
    • Market (not normal for a bond)
  13. Compare T-Bills, T-Notes, and T-Bonds.
    • T-bills: up to 1 year
    • T-notes: 2-10 years
    • T-bonds: >10 years
    • T-bills: zero-coupon, weekly auction
    • T-Notes/Bonds: Semi-annual interest, treasury decides option
    • All federally taxable, but state/local tax exempt
    • No credit risk
  14. How are T-Bills priced?
    • Discount yield basis
    • Bid/Ask: 2.94%/2.90%
    • =100-2.94/100-2.9
    • =97.06/97.1
  15. How can treasury investors protect themselves from inflation?
    • Acquire a TIPS (Treasury Inflation-Protected Security)
    • These offer a stated coupon with interest paid semi-annually BUT the principal (par value) is increased/decreased based on the CPI
  16. What is a T-strip?
    • It's a part of a T-bond or T-note--a long term, zero coupon.
    • It's one of the strips on a T-bond or T-note
    • They are issued at a discount and then mature
  17. What are agency securities?
    • Debt instruments issued by Jennie Mae, Fannie Mae, or Freddie Mac (GNMA, FNMA, FHLMC -- government national, national, and fed. national mortgage association)
    • They're issued in book-entry form
    • Only GNMA are guaranteed
    • Interest is fully taxable
    • They pay out monthly (interest + principal)
  18. What risk are agency securities subject to?
    Prepayment risk
  19. What is a pass-through
    It's an agency security backed by mortgages. They are high credit quality and can supplement retirement income. Only GNMA are guaranteed.
  20. What is a GO bond?
    • Issued by states, counties, cities, or territories
    • They are paid for by taxes and they're used to meet general gov't needs.
    • The interest is tax exempt
  21. What is a revenue bond?
    • They are bonds issued by gov'ts to fund a specific project. Their credit risk is high because they're paid for by the project's revenue
    • They are tax-exempt
  22. What are the orders in a liquidation proceeding?
    • 1. IRS taxes/unpaid wages
    • 2. Secured creditors
    • 3. General creditors (unsecured/debentures)
    • 4. Subordinated creditors
    • 5. Preferred stockholders
    • 6. Common stockholders
  23. What are money market instruments?
    • Made up of short-term debt, they are the safest possible and can be used to keep money safe while waiting to invest (very liquid), and repos
    • They include T-bills, BAs, CDs, commercial paper (unsecured corp. debt)
    • FDIC will insure them
Card Set
SIE 4/5 - Debt Instruments
SIE 4/5 - Debt Instruments