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103
CHAPTER 1
FIXEDINCOME SECURITIES:
DEFINING ELEMENTS
SOLUTIONS
four years ago. us, there are six years remaining until the maturity date.
B is incorrect because the nominal rate is the coupon rate—that is, the interest
A is incorrect because a perpetual bond does not have a stated maturity date. us,
the sovereign bond, which has a maturity of 15 years, cannot be a perpetual bond. B is
0.65% = 2.20%.
104 Part II: Solutions
bond will reimburse investors for any losses, usually up to a maximum amount called
the penal sum.
cess of posting more collateral than is needed to obtain or secure nancing. Collateral,
such as assets or securities pledged to ensure debt payments, is not provided by a third
the issuer intends to do with the proceeds from the bond issue.
current lines of business are positive covenants.
and at least one domestic country simultaneously.
bonds. C is incorrect because Eurobonds are typically subject to lower, not greater, regu-
lation than domestic and foreign bonds.
tax deduction in the year the bond is purchased or afterward.
payments prior to maturity. e entire principal repayment occurs at maturity.
Chapter 1 Fixed-Income Securities: De ning Elements 105
ments and/or principal repayment linked to an index of consumer prices. If interest
rates increase as a result of in ation, this feature is a bene t for the bondholders, not
intervals. Consequently, FRNs are favored by investors who believe that interest rates will
rise.
rising interest rate environment. Consequently, investors who expect interest rates to rise
will likely avoid investing in xed-rate bonds.
cipal amount increases by 2% and the coupon payment is based on the in ation-adjusted
principal amount. On the rst coupon payment date, the in ation-adjusted principal
amount is 1,000 × (1 + 0.02) = 1,020 and the semi-annual coupon payment is equal to
(0.06 × 1,020) ÷ 2 = 30.60.
and principal repayments not paid because of the bond being redeemed early by the issuer.
C is incorrect because an original issue discount provision is a tax provision relating to
bonds issued at a discount to par value. e original issue discount tax provision typically
requires the bondholders to include a prorated portion of the original issue discount (i.e.,
the di erence between the par value and the original issue price) in their taxable income
every tax year until the bond’s maturity date.
issuer’s credit quality improves, the issuer of a callable bond can redeem it and replace it
by a cheaper bond. us, the call provision is bene cial to the issuer.
issuing company’s share price increases, the bondholders have the right to exchange the
bond for a speci ed number of common shares in the issuing company.
106 Part II: Solutions
price of an otherwise similar non-convertible bond.
