Key Features of a Bond
A. What are the key features of a bond?
answer: if possible, begin this lecture by showing students an actual bond certificate. We show a real coupon bond with physical coupons. These can no longer be issued--it is too easy to evade taxes, especially estate taxes, with bearer bonds. All bonds today must be registered, and registered bonds don't have physical coupons.
1. Par or face value. We generally assume a $1,000 par value, but par can be anything, and often $5,000 or more is used. With registered bonds, which is what are issued today, if you bought $50,000 worth, that amount would appear on the certificate.
2. Coupon rate. The dollar coupon is the "rent" on the money borrowed, which is generally the par value of the bond. The coupon rate is the annual interest payment divided by the par value, and it is generally set at the value of k on the day the bond is issued. To illustrate, the required rate of return on one of southern bell's bonds was 11 percent when they were issued, so the coupon rate was set at 11 percent. If the company were to float a new issue today, the coupon rate would be set at the going rate today (october 1998), which would be about 7.4%.
3. Maturity. This is the number of years until the bond matures and the issuer must repay the loan (return the par value). The southern bell bonds had a 30-year maturity when they were issued, but the maturity declines by 1 year each year after their issue.
4. Issue date. The southern bell bonds were issued in 1977, when interest rates were higher than they are today.
5. Default risk is inherent in all bonds except treasury bonds--will the issuer have the cash to make the promised payments? Bonds are rated from aaa to d, and the lower the rating the riskier the bond, the higher its default risk premium, and, consequently, the higher its required rate of return, k. Southern bell is rated aaa.
B. What are call provisions and sinking fund provisions? Do these provisions
answer: if possible, begin this lecture by showing students an actual bond certificate. We show a real coupon bond with physical coupons. These can no longer be issued--it is too easy to evade taxes, especially estate taxes, with bearer bonds. All bonds today must be registered, and registered bonds don't have physical coupons.
1. Par or face value. We generally assume a $1,000 par value, but par can be anything, and often $5,000 or more is used. With registered bonds, which is what are issued today, if you bought $50,000 worth, that amount would appear on the certificate.
2. Coupon rate. The dollar coupon is the "rent" on the money borrowed, which is generally the par value of the bond. The coupon rate is the annual interest payment divided by the par value, and it is generally set at the value of k on the day the bond is issued. To illustrate, the required rate of return on one of southern bell's bonds was 11 percent when they were issued, so the coupon rate was set at 11 percent. If the company were to float a new issue today, the coupon rate would be set at the going rate today (october 1998), which would be about 7.4%.
3. Maturity. This is the number of years until the bond matures and the issuer must repay the loan (return the par value). The southern bell bonds had a 30-year maturity when they were issued, but the maturity declines by 1 year each year after their issue.
4. Issue date. The southern bell bonds were issued in 1977, when interest rates were higher than they are today.
5. Default risk is inherent in all bonds except treasury bonds--will the issuer have the cash to make the promised payments? Bonds are rated from aaa to d, and the lower the rating the riskier the bond, the higher its default risk premium, and, consequently, the higher its required rate of return, k. Southern bell is rated aaa.
B. What are call provisions and sinking fund provisions? Do these provisions