COB 300 FINANCE EXAM #3
DEFINITIONS QUESTIONS AND
ANSWERS
Deferred Call Provision - Answer-- time limited
- call cannot be executed until deferral date
Call Protected Bond - Answer-keeps issuers from calling the bond, usually a set time
period
Why would businesses want to call a bond early? - Answer-if market interest rates move
in ways that would allow them to make more money in other ways
- CALL IF RATES ARE LOWER THAN WHAT YOU ARE PAYING
Protective Covenant - Answer-a part of the indenture limiting certain actions that might
be taken during the term of the loan, usually to protect the lender's interest
Positive Covenant - Answer-specifies an action the company agrees to take or a
condition the company must abide by
Negative Covenant - Answer-do not have to do anything with the money
- states what you cannot do
Technical Default - Answer-have not missed payments, but have went back on
agreement in some way
Sinking Fund Provision - Answer-a provision in a bond contract that requires the issuer
to retire a portion of the bond issue each year
- 'automatic call'
Nationally Recognized Statistical Rating Organizations (NRSROs) - Answer-determine
the credit worthiness of the issuer, tempered by features of the debt obligation
High Grade - Answer-Moody's Aaa and S&P AAA - capacity to pay is extremely strong
Moody's Aa and S&P AA - capacity to pay is very strong
Medium Grade - Answer-Moody's A and S&P A - capacity to pay is strong, but more
susceptible to changes in circumstances
Moody's Baa and S&P BBB - capacity to pay is adequate, adverse conditions will have
more impact on the firm's ability to pay
Low Grade - Answer-Moody's Ba and B
S&P BB and B
, Considered possible that the capacity to pay will degenerate.
Very Low Grade - Answer-Moody's C and S&P C - income bonds with no interest being
paid
Moody's D and S&P D - in default with principal and interest in arrears
Value of a Straight Bond - Answer-is the present value of the future cash flows of the
bond, which consists of interest payments and the par value repaid at maturity
Yield to Maturity - Answer-the rate required in the market on a bond
- yield if bond is held to maturity
Yield to Call - Answer-the rate of return earned on a bond when it is called before its
maturity date
- yield if 'Called Away'
Current Yield - Answer-a bond's annual coupon divided by its price
If coupon interest rate exactly equals discount rate (yield), then the bond value today
will always ____ - Answer-equal the par value
If the Yield to Maturity is greater than the coupon rate, then value of bond will always be
____ - Answer-less than par value
- AKA DISCOUNT BOND
If the Yield to Maturity is less than coupon rate, then the value of the bond will be _____
- Answer-greater than par value
- PREMIUM BOND
Discount Bond - Answer-A bond that sells below its par value; occurs whenever the
going rate of interest is above the coupon rate
Premium Bond - Answer-a bond that sells above its par value; occurs whenever the
going rate of interest is below the coupon rate
Treasury Bill (T-Bill) - Answer-A short-term debt obligation backed by the U.S.
government with a maturity of less than one year.
- sold through auctions
-- competitive
-- non-competitive
Spread - Answer-difference between any two interest rate
- quoted in basis points (bp) of which each is 1/100th of a percent
- EX: two investments have 4% and 4.5%... bp = 50
Term Structure - Answer-relationship between time to maturity and yields, all else equal
DEFINITIONS QUESTIONS AND
ANSWERS
Deferred Call Provision - Answer-- time limited
- call cannot be executed until deferral date
Call Protected Bond - Answer-keeps issuers from calling the bond, usually a set time
period
Why would businesses want to call a bond early? - Answer-if market interest rates move
in ways that would allow them to make more money in other ways
- CALL IF RATES ARE LOWER THAN WHAT YOU ARE PAYING
Protective Covenant - Answer-a part of the indenture limiting certain actions that might
be taken during the term of the loan, usually to protect the lender's interest
Positive Covenant - Answer-specifies an action the company agrees to take or a
condition the company must abide by
Negative Covenant - Answer-do not have to do anything with the money
- states what you cannot do
Technical Default - Answer-have not missed payments, but have went back on
agreement in some way
Sinking Fund Provision - Answer-a provision in a bond contract that requires the issuer
to retire a portion of the bond issue each year
- 'automatic call'
Nationally Recognized Statistical Rating Organizations (NRSROs) - Answer-determine
the credit worthiness of the issuer, tempered by features of the debt obligation
High Grade - Answer-Moody's Aaa and S&P AAA - capacity to pay is extremely strong
Moody's Aa and S&P AA - capacity to pay is very strong
Medium Grade - Answer-Moody's A and S&P A - capacity to pay is strong, but more
susceptible to changes in circumstances
Moody's Baa and S&P BBB - capacity to pay is adequate, adverse conditions will have
more impact on the firm's ability to pay
Low Grade - Answer-Moody's Ba and B
S&P BB and B
, Considered possible that the capacity to pay will degenerate.
Very Low Grade - Answer-Moody's C and S&P C - income bonds with no interest being
paid
Moody's D and S&P D - in default with principal and interest in arrears
Value of a Straight Bond - Answer-is the present value of the future cash flows of the
bond, which consists of interest payments and the par value repaid at maturity
Yield to Maturity - Answer-the rate required in the market on a bond
- yield if bond is held to maturity
Yield to Call - Answer-the rate of return earned on a bond when it is called before its
maturity date
- yield if 'Called Away'
Current Yield - Answer-a bond's annual coupon divided by its price
If coupon interest rate exactly equals discount rate (yield), then the bond value today
will always ____ - Answer-equal the par value
If the Yield to Maturity is greater than the coupon rate, then value of bond will always be
____ - Answer-less than par value
- AKA DISCOUNT BOND
If the Yield to Maturity is less than coupon rate, then the value of the bond will be _____
- Answer-greater than par value
- PREMIUM BOND
Discount Bond - Answer-A bond that sells below its par value; occurs whenever the
going rate of interest is above the coupon rate
Premium Bond - Answer-a bond that sells above its par value; occurs whenever the
going rate of interest is below the coupon rate
Treasury Bill (T-Bill) - Answer-A short-term debt obligation backed by the U.S.
government with a maturity of less than one year.
- sold through auctions
-- competitive
-- non-competitive
Spread - Answer-difference between any two interest rate
- quoted in basis points (bp) of which each is 1/100th of a percent
- EX: two investments have 4% and 4.5%... bp = 50
Term Structure - Answer-relationship between time to maturity and yields, all else equal
