ACC501 Lecture-wise Short Questions

LECTURE # 19

What is always true about the relationship between bond prices and market interest rates?

Answer: Bond prices and market interest rates move in opposite directions.

How does the market value of a bond compare to its par value when the bond's coupon rate is equal to the market's required return?

Answer: The bond's market value will be equal to its par value.

How does the price of a longer-term bond change compared to a shorter-term bond for a given change in market interest rates?

Answer: The price of the longer-term bond will change more than that of the shorter-term bond.

What happens to the price of a lower-coupon bond compared to a higher-coupon bond for a given change in market interest rates?

Answer: The price of the lower-coupon bond will change more than that of the higher-coupon bond.

How is the yield to maturity (YTM) of a bond calculated?

Answer: The yield to maturity is the unknown discount rate (r) that solves the bond pricing equation.

What can be said about the yield to maturity (YTM) if a bond is selling at a discount?

Answer: The yield to maturity is greater than the market's required return (greater than 8%).

How can the yield to maturity (YTM) be found for a given bond value, coupon, time to maturity, and face value?

Answer: The yield to maturity can be found through trial and error by trying different discount rates until the calculated bond value equals the given bond value.

What are the main differences between debt and equity securities?

Answer: Debt is not an ownership interest in the firm and creditors generally do not have voting power. Interest on debt is tax-deductible, while dividends paid to stockholders are not. Unpaid debt is a liability of the firm, which can lead to bankruptcy or financial failure if not paid, whereas equity does not have this risk.

What distinguishes long-term debt securities from short-term debt securities?

Answer: Maturity is the key distinction, where long-term debt remains outstanding for a longer period, while short-term debt matures in one year or less.

What is the denomination of the bonds issued by Super Stores in the example provided?

Answer: The denomination of the bonds is $1,000.

What is the annual coupon rate for Super Stores' bonds in the example?

Answer: The annual coupon rate is 9.25%.

When will Super Stores pay the coupon on its bonds?

Answer: Coupons of $46.25 will be paid on the 1st of March and 1st of September.

Does the Super Stores bond have a call provision?

Answer: Yes, the bonds have a deferred call feature before 28th Feb. 1993.

What is the rating of Super Stores' bonds?

Answer: The rating is A2, indicating a higher rating and a low probability of default.

LECTURE # 20

What is a bond indenture, and what is the role of the trustee in it?

Answer: The bond indenture is a contract between the bond issuer and bondholders. The trustee, usually a bank, is hired to protect the bondholders' interests, ensuring that the terms of the indenture are obeyed, managing the sinking fund, and representing bondholders in default.

What are the key components included in a bond indenture?

Answer: The bond indenture includes the basic terms of the bond issue, the total amount of bonds issued, a description of the security, the repayment arrangements, the call provisions, and details of the protective covenants.

What is the par value of a bond, and how does it relate to the face value?

Answer: The par value of a bond is almost always the same as the face value, and the terms are used interchangeably. Corporate bonds usually have a face value of $1000, which is also known as the principal value stated on the bond certificate.

How do registered and bearer bonds differ in terms of ownership and coupon payment?

Answer: Registered bonds have ownership recorded by the company, and interest and principal payments are made by cheque directly to the bondholder. In contrast, bearer bonds do not have recorded ownership, and interest is obtained by detaching coupons from the bond certificate and sending them to the company for payment.

What is the purpose of collateral and mortgage securities in debt securities?

Answer: Collateral and mortgage securities are used to protect bondholders. Collateral involves assets pledged as security for payment of debt, while mortgage securities are secured by a mortgage on the borrower's real property.

How does seniority affect bondholders in the event of default?

Answer: Seniority indicates preference in position over lenders, with some debts labeled as senior or junior. In case of default, holders of subordinated debt must give preference to other specified creditors.

What is a sinking fund, and how is it used for bond repayment?

Answer: A sinking fund is an account managed by the bond trustee to repay bonds. The company makes annual payments to the trustee, who retires a portion of the debt either by buying up some bonds or calling in a fraction of outstanding bonds.

What is a call provision, and how does it affect bondholders?

Answer: A call provision allows the company to repurchase part or all of the bond issue at specified prices over a specific period. The call price is typically above the bond's stated value (par value), and the amount of premium declines as the call date approaches.

What are protective covenants, and what are the two types mentioned?

Answer: Protective covenants are limitations on certain actions a company might take during the loan term. The two types are negative covenants, which prohibit actions, and positive covenants, which specify actions the company must take.

How are bond ratings determined, and what do they assess?

Answer: Bond ratings are based on the creditworthiness of the corporate issuer, assessing the likelihood of default and the protection creditors have in the event of a default.

What does a PACRA rating of "AAA" indicate?

Answer: A PACRA rating of "AAA" indicates the highest credit quality and the lowest expectation of credit risk.

How are short-term bond ratings different from long-term ratings in PACRA's rating system?

Answer: Short-term ratings assess the capacity for timely repayment in the short term, while longterm ratings evaluate credit risk over an extended period.

LECTURE # 21

What are government bonds, and what is their default risk?

Answer: Government bonds are treasury notes and bonds issued by the government for borrowing money for more than one year. They have no default risk.

What are zero coupon bonds, and how do they differ from ordinary coupon bonds?

Answer: Zero coupon bonds pay no coupon and are offered at a much lower price than their stated value. In contrast, ordinary coupon bonds pay regular interest (coupon) and are issued at or near their

How is the interest on zero coupon bonds deducted for tax purposes?

Answer: For tax purposes, the issuer of a zero coupon bond deducts interest every year, even though no interest is actually paid. This deduction reduces the taxable income, resulting in lower yields compared to taxable bonds.

What are floating rate bonds, and how are their coupon payments adjusted?

Answer: Floating rate bonds have coupon payments adjustable based on an interest rate index, such as treasury bills interest rate. The coupon adjusts with a lag to some base rate.

What is the characteristic feature of inflation-linked bonds, and how are their coupons adjusted?

Answer: Inflation-linked bonds have coupons adjusted according to the rate of inflation. The principal amount may also be adjusted based on inflation.

What are income bonds, and how are their coupon payments determined?

Answer: Income bonds have coupon payments that depend on the company's income being sufficient to support such payments.

What is unique about convertible bonds, and when can they be exchanged for shares?

Answer: Convertible bonds can be exchanged for a fixed number of shares at any time before maturity at the holder's option.

What is the Fisher Effect, and how does it relate to real and nominal returns?

Answer: The Fisher Effect describes the relationship between real and nominal returns. It states that the nominal return is equal to the real return plus the inflation rate, or R = r + h.

What is the real rate of return, and how is it affected by inflation?

Answer: The real rate of return is the percentage change in the amount of stuff you can actually buy. It is affected by inflation, and the formula to calculate it is r = (1 + R) / (1 + h) - 1.