10.8: Key Terms

bond call

a feature of certain bonds or other fixed-income instruments that allows the issuer to repurchase and retire these instruments before maturity

bond price

the present, discounted value of the future cash stream generated by a bond; the sum of the present values of all likely coupon payments and the present value of the par value at maturity

bond ratings

grades assigned to bonds by rating services that indicate their overall credit quality

Business Cycle Dating Committee

a subdivision of the National Bureau of Economic Research (NBER), the US government agency that maintains a chronology of US business cycles

call risk

the risk that a bond issuer will redeem a callable bond prior to maturity

capital gains

the increase in a capital asset’s value that is realized when the asset is sold

cash rate

the interest rate that a central bank, such as the Reserve Bank of Australia or the US Federal Reserve System, will charge commercial banks for loans; also known as the bank rate or the base interest rate

convertible bonds

fixed-income corporate debt securities that yield interest payments but can be converted into a predetermined number of common stock or equity shares

coupon payment

the periodic dollar value of interest that is paid to a bondholder by the bond issuer

coupon rate

the amount of annual interest paid by the bond issuer; is multiplied by the face value of a bond to determine annual interest or coupon payment amounts

credit risk

the risk taken by a bond investor that the bond issuer will default by failing to pay interest and repay the principal on schedule

deep discount bonds

bonds that sell at significantly lower values than their par values

default

when an issuer fails to make scheduled interest or principal payments on its bonds

default risk

the risk taken by investors that payments will be delayed or will not occur

discount bond

a bond currently trading for less than its par value in the secondary market; offers a coupon rate that is lower than prevailing interest rates

duration

a measure of how much bond prices are likely to change if and when interest rates move

duration risk

the risk associated with the sensitivity of a bond’s price to a 1% change in interest rates

Federal Reserve funds rate (federal funds rate)

the target interest rate, set by the Federal Reserve, at which commercial banks borrow and lend their excess reserves to each other

Federal Reserve System (the Fed)

the central banking system of the United States, responsible for administering fiscal policy for the country

fixed-income securities

investments that provide a return in the form of fixed, periodic interest payments and the eventual return of principal at maturity; the most common forms are bonds

floating-rate bonds

bonds with variable interest rates that allow investors to benefit from rising interest rates

interest income

annual interest amounts paid, or coupon payments made, on a bond between its issue date and the date of maturity

interest rate risk

the risk of investment losses that result from changes in interest rates

investment grade

describes a municipal or corporate bond with a rating that indicates it presents a low risk of default

junk bonds

bonds that have been given a low credit rating, below investment grade; riskier than other bonds due to a greater chance that the issuer will default or experience a credit event

liquidity risk

risk that stems from the lack of marketability of an investment, meaning that it cannot be bought or sold quickly enough to prevent or minimize a loss

London Interbank Offered Rate (LIBOR)

a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans

maturity date

the date on which a bondholder ceases to receive interest payments on a bond investment and instead is repaid its par, or face, value

municipal bonds (“munis”)

debt securities issued by state and local governments; can be thought of as loans that investors make to local governments to fund infrastructure

par value

also called the face amount or face value; the value written on the front of the bond, which is the amount of money that bond issuers promise to be paid at maturity

premium bond

a bond that is trading above its par value in the secondary market; offers a coupon rate that is higher than the current prevailing interest rates being offered

prime rate

the interest rate that banks charge creditworthy corporate customers; among the most widely used benchmarks for setting home equity lines of credit and credit card rates, based on the federal funds rate set by the Federal Reserve

rating agencies (bond rating services)

independent service agencies, such as Fitch, Moody’s, or Standard & Poor’s, that perform the isolated function of credit risk evaluation

realized return

the actual return that an investor earns over a given time period through the buying and selling of a security

reinvestment risk

the risk that an investor will be unable to reinvest cash flows received from an investment (e.g., coupon payments or interest) at a rate comparable to their current rate of return

savings bonds

debt securities purchased by investors, as a personal investments or as gifts, that the US government issues to pay for certain public or government programs

term risk

the risk of potentially earning lower returns on longer-term bond holdings compared to those potentially available when making several shorter-term investments over the same period of time

US Treasury bills (T-bills)

short-term US government debt obligations backed by the Treasury Department with a maturity of one year or less

US Treasury note rate

the interest rate that the US government pays to borrow money for different lengths of time; notes are issued in terms of two, three, five, seven, and 10 years

yield curve

a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates; gives an idea of future interest rate changes and economic activity

yield to maturity (YTM)

the total return anticipated on a bond if the investment is held until maturity

zero-coupon bonds

bonds that are issued at a deep discount from face value and offer no interest or coupon payments