Question

I. Define the following:

a. Bond:

b. Par Value:

c. Maturity:

d. Call Feature:

e. Convertible Bond:

f. Yield to Maturity:

II. Identify Different Types of Bonds

a. Treasury:

b. Municipal:

c. Federal Agency Bonds:

d. Corporate:

e. High Yield (Junk) Bonds:

III. Explain What Affects the Return from Investing in Bonds:

IV. Describe Why Some Bonds are Risky:

a. Default Risk:

b. Risk Premium:

c. Impact of Economic Conditions

V. Identify Common Bond Investment Strategies:

a. Interest Rate Strategy:

b. Passive Strategy:

c. Maturity Matching

Answer 1

Answer I:

a. Bonds: A bond is a type of indebtedness instrument. It is a fixed income instrument in which investors invest and it represents the loan given to the company repayable as per the terms and conditions attached to the bond.

b. Par Value: Par value is the face value of the security. It is the original or exact price of the security at which it is to be issued. It specifically excludes any discount or premium attached to the security on the basis of any valuation.

c. Maturity: Maturity means the the time period at which the instrument or security is matured or ends. It is the age of the instrument. The instrument or security tends to end at the time of maturity subject to the renewal or repayment, as per the terms and conditions attached to it.

d. Call feature: Call feature is a feature that gives the bond issuer the right to redeem the bond before its maturity. The issuer of the bond can enforce its repayment at the call price before the expiry of the bond.

e. Convertible Bond: Convertible bond is the bond that can be converted into shares at its maturity. The bond is redeemed or repaid in the form of shares equivalent to the value of bond at the maturity instead of the money.

f. Yield to maturity: It means the total return a bond will generate during its life cycle. It refers to the total amount a bond holder will receive as return if he holds the bond till its maturity.

Answer II:

a. Treasury: Treasury basically means a place where all the currency, gold, instruments are kept by the company or government. It represents the total wealth as held by the company or government at a given point of time.

b. Municipal: Municipal bond is a bond which is issued by the government or the state. It is usually raised to finance the infrastructure or capital expenditures of the country.

c. Federal Agency Bonds: These are the bonds that are issued by the Federal Government Agencies. These are most safe bonds to invest in. They enjoy a risk-free rate of investment.

d. Corporate: Corporate means an entity registered with the government as a corporate or company. The bonds issued by the corporate to the investors are known as corporate bonds. They have a credit rating attached to it depending upon the effectiveness and efficiency and risk associated with the corporate and the bond issued by it.

e. High Yield (Junk) Bonds: These are the high paying bonds held by investors. They usually have lower credit rating as compared to corporate bonds. They have a high risk of default. Therefore, they have high yield so as to attract the investors.

Answer III:

The following affects the return from investing in bonds:

1. Inflation risk

2. Interest rate risk

3. Call risk

4. Credit risk

5. Liquidity risk

6. Market risk

Answer IV:

a. Default risk: It is the risk associated with the bond that a company or the bond issuer wont be able to pay the return or make required payments as attached with the bond.

b. Risk Premium: It is the return which is in excess of the risk-free return on the bond. It is the premium over and above the risk-free rate of investment in the market.

c. Impact of economic conditions: In case of strong economy, there will be higher demand of money in the market and thus the rate of bonds will be high. In case of weaker economies, the rate of interest in the bonds will be low.

Answer V.

a. Interest Rate Strategy: It means a strategy based upon the long-term bonds and short-term bonds based on the interest rates on the bonds. If investors believe that the interest rate will increase in future, they will invest in short-term bonds and vice versa.

b. Passive Strategy: It is generally done by the investors to build wealth and healthy portfolio. The investors buy and hold the bonds to own it for long-term. This is done to slowly build the wealth by the investors.

c. Maturity Matching: It is a form of hedging strategy. It is made to match the future payouts of the bond as per the liabilities that may arise as per the time period and maturity of the bond.