Financial Markets and Institutions (2-downloads)

300

Part 5 Financial Markets

Year

0

1

2

3

4

Cash Flow

160

170

180

230

Bond A

Bond B

Maturity (years)

15

20

Coupon rate (%) 

(paid semiannually)

10

6

Par value

$1,000

$1,000

K E Y   T E R M S

bond indenture, p. 288

call provision, p. 289

coupon rate, p. 281

credit default swap (CDS), p. 293

current yield, p. 294

discount, p. 298

financial guarantees, p. 293

general obligation bonds, p. 287

initial public offering, p. 280

interest-rate risk, p. 298

junk bonds, p. 291

premium, p. 298

registered bonds, p. 289

restrictive covenants, p. 289

revenue bonds, p. 287

Separate Trading of Registered

Interest and Principal Securities

(STRIPS), p. 283

sinking fund, p. 289

zero-coupon securities, p. 284

Q U E S T I O N S

1. Contrast investors’ use of capital markets with their

use of money markets.

2. What are the primary capital market securities, and

who are the primary purchasers of these securities?

3. Distinguish between the primary market and the sec-

ondary market for securities.

4. A bond provides information about its par value,

coupon interest rate, and maturity date. Define each

of these.

5. The U.S. Treasury issues bills, notes, and bonds. How

do these three securities differ?

6. As interest rates in the market change over time,

the market price of bonds rises and falls. The

change in the value of bonds due to changes in

interest rates is a risk incurred by bond investors.

What is this risk called?

7. In addition to Treasury securities, some agencies of

the government issue bonds. List three such agencies,

and state what the funds raised by the bond issues are

used for.

8. A call provision on a bond allows the issuer to redeem

the bond at will. Investors do not like call provisions

and so require higher interest on callable bonds. Why

do issuers continue to issue callable bonds anyway?

9. What is a sinking fund? Do investors like bonds that

contain this feature? Why?

10. What is the document called that lists the terms of 

a bond?

11. Describe the two ways whereby capital market secu-

rities pass from the issuer to the public.

Q U A N T I TAT I V E   P R O B L E M S

1. A bond makes an annual $80 interest payment 

(8% coupon). The bond has five years before it

matures, at which time it will pay $1,000. Assuming

a discount rate of 10%, what should be the price of

the bond? (Review Chapters 3 and 12.)

2. A zero-coupon bond has a par value of $1,000 and

matures in 20 years. Investors require a 10% annual

return on these bonds. For what price should the

bond sell? (Note: Zero-coupon bonds do not pay any

interest. Review Chapter 3.)