Bond Prices and Yields
a. Catastrophe bond: Typically issued by an insurance company. They are similar to an insurance policy in that the investor receives coupons and par value, but takes a loss in part or all of the principal if a major insurance claim is filed against the issuer. This is provided in exchange for higher than normal coupons.
b. Eurobond: They are bonds issued in the currency of one country but sold in other national markets.
c. Zero-coupon bond: Zero-coupon bonds are bonds that pay no coupons but do pay a par value at maturity.
d. Samurai bond: Yen-denominated bonds sold in Japan by non-Japanese issuers are called Samurai bonds.
e. Junk bond: Those rated BBB or above (S&P, Fitch) or Baa and above (Moody’s) are considered investment grade bonds, while lower-rated bonds are classified as speculative grade or junk bonds.
f. Convertible bond: Convertible bonds may be exchanged, at the bondholder’s discretion, for a specified number of shares of stock. Convertible bondholders “pay” for this option by accepting a lower coupon rate on the security.
g. Serial bond: A serial bond is an issue in which the firm sells bonds with staggered maturity dates. As bonds mature sequentially, the principal repayment burden for the firm is spread over time just as it is with a sinking fund. Serial bonds do not include call provisions.
h. Equipment obligation bond: A bond that is issued with specific equipment pledged as collateral against the bond.
i. Original issue discount bonds: Original issue discount bonds are less common than coupon bonds issued at par. These are bonds that are issued intentionally with low coupon rates that cause the bond to sell at a discount from par value.
j. Indexed bond: Indexed bonds make payments that are tied to a general price index or the price of a particular commodity.
2. Callable bonds give the issuer the option to extend or retire the bond at the call date, while the extendable or puttable bond gives this option to the bondholder.
a. YTM will drop since the company has more money to pay the interest on its bonds.
b. YTM will increase since the company has more debt and the risk to the existing bondholders is now increased.
c. YTM will decrease since the firm has either fewer current liabilities or an increase in various current assets.
4. Semi-annual coupon = $1,000 6% 0.5 = $30.
Accrued Interest =
= $30 (30/182) = $4.945
At a price of 117, the invoice price is: $1,170 + $4.945 = $1,174.95
5. Using a financial calculator, PV = –746.22, FV = 1,000, n = 5, PMT = 0. The YTM is 6.0295%.
Using a financial calculator, PV = –730.00, FV = 1,000, n = 5, PMT = 0. The YTM is 6.4965%.
6. A bond’s coupon interest payments and principal repayment are not affected by changes in market rates. Consequently, if market rates increase, bond investors in the secondary markets are not willing to pay as much for a claim on a given bond’s fixed interest and principal payments as they would if market rates were lower. This relationship is apparent from the inverse relationship between interest rates and present value. An increase in the discount rate (i.e., the market rate) decreases the present value of the future cash flows.
7. The bond callable at 105 should sell at a lower price because the call provision is more valuable to the firm. Therefore, its yield to maturity should be higher.
8. The bond price will be lower. As time passes, the bond price, which is now above par value, will approach par.
9. Current yield = = = 4.95%
10. a. The purchase of a credit default swap. The investor believes the bond may increase in credit risk, which raises the prices of the credit default swaps because of the widened swap spread.
11. c. When credit risk increases, the swap premium increases because of higher chances of default on the firm. When the interest rate risk increases, the price of the CDS decreases...
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