Bond indenture is a contract that specifies all the rights and obligations of the issuer and the owners.
Contract provisions are called covenants
- negative covenants (prohibits on the borrower)
- restriction of asset sales
- negative pledge colleterals
- restriction on additional borrowings
- affirmative covenants ( actions that the borrower promises to perform)
- maintanance of certain financial ratios
- timely payment of principal and interests
b. describe the basic features of a bond, the various coupon rate structures, and the structure of floating-rate securities;
Embedded options: they are integrated part of the contract and not a seperate security
Security owner options
- Conversion option
- owner has the right to convert the bond into fixed number of common shares of the issiuer
- Put provisions
- owners has the right to sell the bond to the issuer at a specified price before maturiy
- Floors
- set a min. on the coupon rate for the floating rate bonds
- Call provision
- bond issuer has the right to redeem (pay off) the issuer prior to maturiy
- Prepayment options
- e.g. mortgages, and car loans
- Accelerated sinking fund provisions
- Allow issuer to retire a larger proportion of the issue than is required by the sinking fund provision up to a specified limit
- Caps
- set a maximum rate for floating rate bond
- Zero coupon bonds
- no periodic coupon interest payments. They are and par value is paid at maturity
- Accural bonds
- similar to zero coupon bonds but coupon interest rate is compounded
- Setup notes
- coupon rates increase at sepecified rate
- Deferred-coupon bonds
- interest coupon payments are defered for some time
- Coupon rates vary based on specified reference interest rate or index. Coupons are reset periodically (e.g. every 3, 6, or 12 months) and then adds/substracts a margin rate from the referance rate. e.g. refer. rate is U.S. Treasury Secs. or LIBOR
- Quoted Margin can also vary by time. Schedule is refered to as coupon formula.
- new coupon rate = reference rate +/- quoted margin
- Caps and floors
- caps set upper limit
- floors set lower limit
- collars set upper and lower limits
c. define accrued interest, full price, and clean price;
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d. explain the provisions for redemption and retirement of bonds;
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e. identify the common options embedded in a bond issue, explain the importance of embedded options, and state whether such options benefit the issuer or the bondholder;
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f. describe methods used by institutional investors in the bond market to finance
the purchase of a security (i.e., margin buying and repurchase agreements).
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