Fina 4500 QUESTIONS AND CORRECT DETAILED
ANSWERS (VERIFIED ANSWERS) |ALREADY
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What are covenants in bonds?
Clauses that specify triggers at which some control rights transfer to creditors
- Triggers are generally financial rations (ex: current ratio value)
- Covenant violation is considered a technical default
- Covenant violations leads to restrictions on corporate activity such as dividend distribution,
acquisitions, etc.
What is seniority in bonds?
Seniority is where the bond lies in the priority order of payments
ex: senior, subordinated senior, junior
What is security in bonds?
Security refers to whether any specific assets secure the bond
- Most bonds are generally unsecured
What are convertible bonds?
When bondholder has the right to convert the bond to equity
- Contract specifies ratio at which a bond is converted to a number of shares (ex: 1 bond
converted to 10 shares)
- Makes sense if stock price has gone up- convert bond to get benefit of high stock price
What are callable bonds?
Issuer has the right to call (or redeem or pay off) the bond before maturity
- contract specifies call price at which bond is called
,- Makes sense if interest rates have gone down- issue bond at lower coupon rate and use
proceeds to call existing bonds
What is the conversion ratio?
The number of shares received upon conversion of a convertible bond, usually stated per
$1,000 of face value
What is the conversion price?
The face value of a convertible bond divided by the number of shares received if the bond is
converted
When should you convert a bond?
When the conversion price is less then the current stock price
What happens to a bond on the call date?
If the yield of the callable bond is less than the coupon, the issuer will call the bond at par and it
will trade a par (the call price)
If the yield is greater than the coupon, the issuer will NOT call the bond, so it has the same price
as the non-callable bond
What is the yield to call?
Annual yield of a callable bond assuming that the bond is called at the earliest opportunity
What is the realized yield?
The return earned on a bond given the cash flows actually received by the investor
- Yield to call is basically realized yield
- The realized yield allows investors to see what they actually earned on their investments
When does realized yield = YTM
, When:
- You can re-invest the coupons at the same rate AND
- You hold the bond until maturity
Why do realized bond and YTM normally not equal each other?
- You must reinvest the coupons at a different rate, or
- You sell the bond before maturity at a price that corresponds to a different yield-to-maturity
(market yields can change)
**So Bonds are RISKY even without default risk!
Who benefits from the added feature of a bond?
- Bondholder
- Issuer
- Its hard to tell
You can tell by comparing the price with feature to price without the feature:
- If feature benefits bondholder, expect price w feature > price without
- If feature benefits issuer, expect price w feature < price without
What is a share/stock?
A share of common stock is an equity security
- It gives its owner a claim to the residual cash flows of a company meaning that Shareholders
always get paid last
- It generally gives its owner a vote, shareholders have primary control over the firm's assets
- Share and stocks are used interchangeably
More shares in company=
Bigger owner= more voting rights
Who owns stocks?
ANSWERS (VERIFIED ANSWERS) |ALREADY
GRADED A+||BRAND NEW
What are covenants in bonds?
Clauses that specify triggers at which some control rights transfer to creditors
- Triggers are generally financial rations (ex: current ratio value)
- Covenant violation is considered a technical default
- Covenant violations leads to restrictions on corporate activity such as dividend distribution,
acquisitions, etc.
What is seniority in bonds?
Seniority is where the bond lies in the priority order of payments
ex: senior, subordinated senior, junior
What is security in bonds?
Security refers to whether any specific assets secure the bond
- Most bonds are generally unsecured
What are convertible bonds?
When bondholder has the right to convert the bond to equity
- Contract specifies ratio at which a bond is converted to a number of shares (ex: 1 bond
converted to 10 shares)
- Makes sense if stock price has gone up- convert bond to get benefit of high stock price
What are callable bonds?
Issuer has the right to call (or redeem or pay off) the bond before maturity
- contract specifies call price at which bond is called
,- Makes sense if interest rates have gone down- issue bond at lower coupon rate and use
proceeds to call existing bonds
What is the conversion ratio?
The number of shares received upon conversion of a convertible bond, usually stated per
$1,000 of face value
What is the conversion price?
The face value of a convertible bond divided by the number of shares received if the bond is
converted
When should you convert a bond?
When the conversion price is less then the current stock price
What happens to a bond on the call date?
If the yield of the callable bond is less than the coupon, the issuer will call the bond at par and it
will trade a par (the call price)
If the yield is greater than the coupon, the issuer will NOT call the bond, so it has the same price
as the non-callable bond
What is the yield to call?
Annual yield of a callable bond assuming that the bond is called at the earliest opportunity
What is the realized yield?
The return earned on a bond given the cash flows actually received by the investor
- Yield to call is basically realized yield
- The realized yield allows investors to see what they actually earned on their investments
When does realized yield = YTM
, When:
- You can re-invest the coupons at the same rate AND
- You hold the bond until maturity
Why do realized bond and YTM normally not equal each other?
- You must reinvest the coupons at a different rate, or
- You sell the bond before maturity at a price that corresponds to a different yield-to-maturity
(market yields can change)
**So Bonds are RISKY even without default risk!
Who benefits from the added feature of a bond?
- Bondholder
- Issuer
- Its hard to tell
You can tell by comparing the price with feature to price without the feature:
- If feature benefits bondholder, expect price w feature > price without
- If feature benefits issuer, expect price w feature < price without
What is a share/stock?
A share of common stock is an equity security
- It gives its owner a claim to the residual cash flows of a company meaning that Shareholders
always get paid last
- It generally gives its owner a vote, shareholders have primary control over the firm's assets
- Share and stocks are used interchangeably
More shares in company=
Bigger owner= more voting rights
Who owns stocks?
