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Problem Sets (Paraphrase with your own words.)

Explain Bond Characteristics (general perspective).

A bond is a security that is issued in connection with a borrowing arrangement. The borrower issues (i.e., sells) a bond to the lender for some amount of cash; the bond is in essence the “IOU” (I owe you) of the borrower.

The arrangement obligates the issuer to make specified payments to the bondholder on specified dates. A typical coupon bond obligates the issuer to make semiannual payments of interest, called coupon payments, to the bondholder for the life of the bond.

To illustrate, a bond with a par value of $1,000 and a coupon rate of 8% might be sold to a buyer for $1,000. The issuer then pays the bondholder 8% of $1,000, or $80 per year, for the stated life of the bond, say, 30 years.

The $80 payment typically comes in two semiannual installments of $40 each. At the end of the 30-year life of the bond, the issuer also pays the $1,000 par value to the bondholder.

Sometimes, however, zero-coupon bonds are issued that make no coupon payments. In this case, investors receive par value at the maturity date but receive no interest payments until then: The bond has a coupon rate of zero.

These bonds are issued at prices considerably below par value, and the investor’s return comes solely from the difference between issue price and the payment of par value at maturity.

7/25/2020

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