Call and Sinking Fun Provisions
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A. What are bond's key features?
b. What are call provisions and sinking fun provisions? Do these provisions make funds more or less risky?
c. How is the value of any asset whose value is based on expected future cash flows determined?
g. What is interest rate (or price) risk? Which has more interest rate risk, an annual payment 1-year bond or a 10-year bond? Why?
h. What is reinvestment rate risk? Which has more reinvestment rate risk, a 1-year bond or a 10-year bond?
i. How does the equation for valuing a bond change if semiannual payments are made? Find the value of a 10-year, semiannual payment, 10% coupon bond if nominal rd=13%.
l. Does the yield to maturity represent the promised or expected return on the bond? Explain.
m. These bonds were rated AA-by S&P. Would you consider them investment-grade or junk bonds?
n. What factors determine a company's bond rating?
o. If this firm were to default on the bonds, would the company be immediately liquidated? Would the bond-holders be assured of receiving all of their promised payments? Explain.
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This solution provides a discussion of a series of business questions
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a. What are bond's key features?
* The key features of a bond are its par/face value, the coupon rate (this is the rate which the investment is to be paid at during purchase), the market rate/current yield to maturity, and the time frame of the bond.
b. What are call provisions and sinking fun provisions? Do these provisions make funds more or less risky?
* Call provisions are statutes governing bonds that gives the issuers of the bond, preferred stock and any other issuers the right but not the responsibility to redeem a security prior to its maturity. On the other hand, a sinking fund provision is a stipulation within a bond in which the borrower can retire a certain proportion of the debt or bond annually. This retirement can be done via calling the bond from investors or buying the same from the open market.
* These provisions make funds less risky since essentially, when bonds are purchased, they are assumed to be held to maturity. Inserting provisions give flexibility based on the conditions contained, therefore reducing the risk element of ...
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