- Other types of bonds
6.1 First Convertible bonds are bonds that are convertible into shares of common
stock, at a fixed price, at the option of the bondholder, Convertibles have a lower
coupon rate than non-convertible debt, but they offer investors a chance for
capital gains in exchange for the lower coupon rate. Bonds issued with warrants
are similar to convertibles. Warrants are options which permit the holder to buy
stock for a stated price, thereby providing a capital gains if the price of the stock
rises. Bonds that are issued with warrants, like convertibles, carry lower coupon
rates than straight bonds.
6.2 Another type of bond is an income bond, which pays interest only if the interest
is earned. These securities cannot bankrupt a company, but from an investor’s
standpoint they are riskier than “regular” bonds. Yet another bond is the indexed,
or purchasing power, bond. The interest rate paid on these bonds is based on
the consumer price index, so the interest paid rises automatically when the
inflation rate rises, thus protecting the bondholders against inflation.
- Bond Valuation
7.1 The value of any financial asset is simply the present value of the cash flows the
asset is expected to produce.
7.2 The cash flows from a specific bond depend on its contractual features.
7.3 The bond’s riskiness, liquidity and years to maturity, as well as supply and
demand conditions in the capital markets - all influence the interest rate on bonds.
7.4 At the time a coupon bond is issued, the coupon is generally set at a level that will
cause the market price of the bond to equal its par value.
7.5 A bond that has just been issued is known as a new issue. Once the bond has been
on the market for a while, it is classified as an outstanding bond, also called a
seasoned issue. Newly issued bonds generally sell very close to par, but the
prices of seasoned bonds often vary widely from par.
- Key Points
Whenever the going rate of interest, is equal to the coupon rate, a fixed-rate bond will sell
at its par value. Normally, the coupon rate is set equal to the going rate when a bond is
issued, causing it to sell at par initially.
- Interest rates do change over time, but the coupon rate remains fixed after the
bond has been issued. Whenever the going rate of interest rises above the
coupon rate, a fixed-rate bond’s price will fall below its par value. Such a bond is
called a discount bond