Fundamentals of Financial Management (Concise 6th Edition)

222 Part 3 Financial Assets

yield below their coupon rate trade at a premium above par. We see that the large

majority of high-yield bonds trade at a discount to par, which suggests that be-

cause of increased default risk, most of these bonds now trade at higher yields

relative to when they were issued. (Recall that most bonds are issued at par, so the

coupon rate tells us what the bond’s yield was at the time it was issued.) You

should also note that when bonds with similar ratings are compared, bonds with

longer maturities tend to have higher yields, which is consistent with the upward-

sloping yield curve during this time period.

SEL

F^ TEST Why do most bond trades occur in the over-the-counter market?

If a bond issue is to be sold at par, at what rate must its coupon rate be set?

Explain.

This chapter described the di# erent types of bonds governments and corporations

issue, explained how bond prices are established, and discussed how investors esti-

mate rates of return on bonds. It also discussed various types of risks that investors

face when they purchase bonds.

When an investor purchases a company’s bonds, the investor is providing the

company with capital. Moreover, when a " rm issues bonds, the return that investors

require on the bonds represents the cost of debt capital to the fi rm. This point is ex-

tended in Chapter 10, where the ideas developed in this chapter are used to help de-

termine a company’s overall cost of capital, which is a basic component of the capital

budgeting process.

In recent years, many companies have used zero coupon bonds to raise billions of

dollars, while bankruptcy is an important consideration for companies that issue debt

and for investors. Therefore, these two related issues are discussed in detail in Web

Appendixes 7A and 7B. Go to the textbook’s web site to access these appendixes.

KEY TERMS Define each of the following terms:

a. Bond; treasury bond; corporate bond; municipal bond; foreign bond

b. Par value; maturity date; original maturity

c. Coupon payment; coupon interest rate

d. Fixed-rate bond; floating-rate bond; zero coupon bond; original issue discount (OID)

bond

e. Call provision; sinking fund provision

f. Convertible bond; warrant; putable bond; income bond; indexed, or purchasing

power, bond

SELF!TEST QUESTIONS AND PROBLEMS

"Solutions Appear in Appendix A

SELF!TEST QUESTIONS AND PROBLEMS

"Solutions Appear in Appendix A

ST-1ST-1

T Y I N G I T A L L T O G E T H E R