: Some of the key features of a bond include the following:
Par or face value
. We generally assume a $1,000 par value, but par can be anything, and
often $5,000 or more is used.
. The dollar coupon is the “rent” on the money borrowed, which is generally the
par value of the bond. The coupon rate is the annual interest payment divided by the par
value, and it is generally set at the value of k on the day the bond is issued. To illustrate, the
required rate of return on one of Tampa Electric’s bonds was 8 percent when they were
issued, so the coupon rate was set at 8 percent. If the company were to float a new issue
today, the coupon rate would be set at the going rate today (2004), which would be about 5
or 6 percent.
This is the number of years until the bond matures and the issuer must repay the
loan (return the par value).
Most bonds (except U.S. Treasury bonds) can be called and paid off ahead of
schedule after some specified “call protection period.” Generally, the call price is above the
par value by some “call premium.” We will see that companies tend to call bonds if interest
rates decline after the bonds were issued, so they can refund the bonds with lower interest
bonds. This is just like homeowners refinancing their mortgages if mortgage interest rates
. The date the bond is originally issued.
is inherent in all bonds except Treasury bonds. The question here is: Will the
issuer have the cash to make the promised payments? Bonds are rated from AAA to D, and
the lower the rating, the riskier the bond, the higher its default risk premium, and,
consequently, the higher its required rate of return, k.
, such as convertibility and zero coupons, will be discussed later.
ROBERT CAMPBELL AND CAROL MORRIS ARE SENIOR VICE
PRESIDENTS OF THE MUTUAL OF CHICAGO INSURANCE COMPANY.
THEY ARE CODIRECTORS OF THE COMPANY’S PENSION FUND
MANAGEMENT DIVISION, WITH CAMPBELL HAVING RESPONSIBILITY
FOR FIXED INCOME SECURITIES (PRIMARILY BONDS) AND MORRIS
BEING RESPONSIBLE FOR EQUITY INVESTMENTS. A MAJOR NEW
CLIENT, THE CALIFORNIA LEAGUE OF CITIES, HAS REQUESTED THAT
MUTUAL OF CHICAGO PRESENT AN INVESTMENT SEMINAR TO THE
MAYORS OF THE REPRESENTED CITIES, AND CAMPBELL AND MORRIS,
WHO WILL MAKE THE ACTUAL PRESENTATION, HAVE ASKED YOU TO
HELP THEM BY ANSWERING THE FOLLOWING QUESTIONS:
WHAT ARE THE KEY FEATURES OF A BOND?