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interest rate risk
the chance of a capital loss due to interest rate fluctuations

Reinvestment rate risk
the chance the FUTURE interest payments will have to be in reinvested at a lower interest rate

discount bond
a bond selling for lower than its par value

Zero coupon bond
 no interest payments
 generally sells at a deep discount and that pays the par value at the maturity due

Assestbacked securities
debt securities whose payments originate from other loans, such as credit cards, auto loans

Premium bond
a bond selling for greater than its par value

agency bonds
bonds issued by US goverment agencies

Mortgagebacked securities
debt securities whose interest and par value payments originate from real estate mortgage payments

bond price
current price that the bond sells for in the bond markets

TIPS
(treasuryinflation protected securities)
US goverment bond the par value of which changes with inflation

call premium
the amount in addition to the par values paid by the issuer when calling a bond

coupon rate
the annual amount of interest paid expressed as a percentage of the bonds par value

Term structure of interest rates
a comparison of market yields on securities assuming all characteristics expect maturity are the same

Current Yield
Return from interest payments
 Annual interest payment /DIVIDED/
 current bond price

Time to Maturity
The length of time in years until the bond matures and the issuer repays the bond value

call
the issuer redeeming the bond before the scheduled maturity date

Maturity date
the calender date on which the bond principal comes due

par value
the amount of debt borrowed to be repaid face value

principal
the face amount, or par value, of debt

indenture agreement
legal contract describing the bond characteristics and the bondholder and issuer rights


fixed income securities
any securities that make fixed payments

amortized loan
loan in which the borrower pays interest and principal over time

loan principal
the balance yet to be paid on a loan

EAR
effective annual rate
 interest rate
 reflects annualizing with componding figured in

APR
Annual precentage rate
interest rate per period X(times) number of pds a yr

console
investment assets structured as perpetuities

perpetiuties
annunity with cash flows that continue forever

annuity
stream of level and fregent cash flows paid at the END of each period
also called an ordinary annuity

Annuity due
an annuity in which cash flows are paid at the BEGINNING of each time period

Discounting
the process of finding PV by using the discount interest rate

discount rate
the interest rate used to discount future cash flows to the present

compounding
adding interest earned every period on the original investment and the reinvested amount

simple interest
interest earned on only the original deposit

Present Value
THe value amount a future cash flow is worth today

Future value
the value amount of a cash flow is worth in one or more periods

Mortgage bonds
bonds secured with real estate as collateral

equipment trust cerificates
bonds secured with factory and equip as collateral

debenture
unsecured bonds

senior bonds
older bonds that carry a higher claim to the issuers assets

junk bonds
low credit quality corporate bonds
also called speculative bonds or high yield bonds

unsecured corporate bonds
corporate debt not secured by collateral such as land, building, or equip

bond rating
a grade of credit quality

investment grade
high credit quality corporate bonds

Taxable equivalent yield
modification of the municipal bonds yield to maturity used to compare muni bond yields to taxable bond yields

credit quality risk
the chance that the issuer will not make timely interset payments or even default

yield to maturity
the total return the bond offers if purchased at the current price and held to maturity

Yield to call
the total return that the bond offers if purchased at the current prices and held until called



compound interest tool for building wealth

interest grows exponentially
small change in interest rate causes the future value to change dramatically

discounting with multiple rates
2500/ (1.07*1.08*1.07)

rule of 72
how many years it takes to DOUBLE an investment
72/interest rate

annuities
level cash flows

Perpetuities Examples
preferred stock

future value of an annuity due
payments occur one period sooner

present value of an annuity due
discount by one less period

amortized loan
divide interest and multiply years by months to calculate monthly payments
 ex
 4yrs = 4X12= 48 months
 9% = 9/12= 0.75% a month
 loan amount = 10,000 (PV)

amortized loans are characterized by level payments

The US bond market is over twice the size of the US stock market

bonds are less risky than stocks

Bonds are DEBT obligations
also known as fixedincome securities

bond is a loan that requires regular interest payments and repayment of the borrowed principal

call feature
allows the issuing firm to refinance when interest rates fall

coupon rate
bonds interest rate

when first issued bonds sell at par value

Three primary types of bonds
 US Treasury bonds
 Corporate bonds
 Municipal bonds

US treasury bonds
backed by the full faith and credit of the US government
safest investments in the world

maturities differ
 less than one yr = treasury bills
 one to ten yrs = treasury notes
 ten yrs or more = treasury bonds

corporate bonds
used by corporations to raise captial
 debt = bonds
 equity =stock

Municipal bonds
issued by state and local governments

TIPS
treasury inflation protected securities
 first issued in 1997
 have fixed coupon rates

corporate bonds are riskier than treasuries and have a higher return

Coupon rate factors:
 1) the amount of uncertainity of company to make payment
 2) the term of the loan
 3) the level of interest rates in the overall economy

municipal bonds have a par value of 5,000

bonds are easier to value than stocks
they know the time remaining to maturity

zero coupon bond
has no interest payments

a bonds interest payments and par value are fixed

short term bonds are less affected by interest rate risk than longterm

to find the paments in coupons
 7% semiannual coupons
 7/2 = 3.5/100
 .035(decimal)*1000 =35 payments

CURRENT YIELD
annual coupon/bond price

YIELD TO MATURITY
measures the total return to bondholder
trying to find I/YR

have to times yield to maturity by 2 for a full year

bonds at discount = greater yield to maturity

bonds at premium = greater coupon that maturity

callable bonds are an advantage for the issuer
disadvantage for the investor

YIELD TO CALL
multiply interest rate by 2 for a full year

Municipal bonds offer lower yields

equivalent taxable yield = muni yield/1taxrate

BB are considered junk or high yield bonds

