MODULE 5- MHA 706
Cost of capital - answer interest rate on debt security and influenced by interest rates.
Factors that influence the general level of interest rates - answer-investment
opportunities
-time preferences for consumption
-risk
-inflation expectations
Investment opportunities and interest rates - answer the more profitable options the
higher the interest rate.
Time preference on interest rates - answer people will prefer short term consumption vs.
long term when make their decision.
inflation on interest rates - answer if investors are expecting it to rise in future, they
would want a premium to ensure dollar amount are equivalent.
Long term debt instruments - answer-Term loans
-Treasury bond
-Corporate bond
-municipal bond
-Corporate bond
-public sale v. private placement
term loan - answerborrower agrees to make a series of interest in principal payment on
specified dates to a lender.
Treasury bond - answermaturity of one year or less
mortgage bonds - answersecured by real assets
Corporate debentures bond - answerno security in terms of having an underlying asset.
Debt contracts - answer-bond indenture
-loan agreement
-promissory note
bond indenture - answerlegal document that list the rights and obligations of the
bondholder and issuer.
, interest rate - answercoupon rate in which the bondholder will be receiving on a regular
basis.
Debt contracts contain - answer-General provisions
-maturity
-type of debt
-interest rate & type
-restrictive covenants
-trustee designation
Restrictive covenants - answerclauses designed to protect the interest of the
bondholder. Bondholder may specify that the organization has to maintain a specific
current ratio.
call provision - answerpermit the borrower to redeem (pay back) the debt prior to
maturity.
Risk of call provision for lender - answerif bond is called they have have to reinvest at a
lower interest rate.
Bond rating criteria - answer-Issuer's financial condition
-competitive situation
-quality of management
Interest rate components - answerinterest rate (required rate of return) on any debt
security can be thought of a base rate plus more components to compensate for risk
and inflation
Interest rate components - answer-RRF = Real risk free (base) rate
-IP = inflation premium
-DRP = default risk premium
-LP = liquidity premium
-PRP= price risk premium
-CRP= call risk premium
Rate= - answerIP + DRP + LP + PRP + CRP
Par value - answerstated face value of the bond. Generally the amount borrowed and
repaid at maturity.
Often $1000 or $5000
Coupon rate - answerstated interest rate on the bond. Multiply by par value to get dollar
coupon payment. Usually fixed
Maturity date - answerdate when the par value will be repaid to investors. Note that
value declines each year after issue.
Cost of capital - answer interest rate on debt security and influenced by interest rates.
Factors that influence the general level of interest rates - answer-investment
opportunities
-time preferences for consumption
-risk
-inflation expectations
Investment opportunities and interest rates - answer the more profitable options the
higher the interest rate.
Time preference on interest rates - answer people will prefer short term consumption vs.
long term when make their decision.
inflation on interest rates - answer if investors are expecting it to rise in future, they
would want a premium to ensure dollar amount are equivalent.
Long term debt instruments - answer-Term loans
-Treasury bond
-Corporate bond
-municipal bond
-Corporate bond
-public sale v. private placement
term loan - answerborrower agrees to make a series of interest in principal payment on
specified dates to a lender.
Treasury bond - answermaturity of one year or less
mortgage bonds - answersecured by real assets
Corporate debentures bond - answerno security in terms of having an underlying asset.
Debt contracts - answer-bond indenture
-loan agreement
-promissory note
bond indenture - answerlegal document that list the rights and obligations of the
bondholder and issuer.
, interest rate - answercoupon rate in which the bondholder will be receiving on a regular
basis.
Debt contracts contain - answer-General provisions
-maturity
-type of debt
-interest rate & type
-restrictive covenants
-trustee designation
Restrictive covenants - answerclauses designed to protect the interest of the
bondholder. Bondholder may specify that the organization has to maintain a specific
current ratio.
call provision - answerpermit the borrower to redeem (pay back) the debt prior to
maturity.
Risk of call provision for lender - answerif bond is called they have have to reinvest at a
lower interest rate.
Bond rating criteria - answer-Issuer's financial condition
-competitive situation
-quality of management
Interest rate components - answerinterest rate (required rate of return) on any debt
security can be thought of a base rate plus more components to compensate for risk
and inflation
Interest rate components - answer-RRF = Real risk free (base) rate
-IP = inflation premium
-DRP = default risk premium
-LP = liquidity premium
-PRP= price risk premium
-CRP= call risk premium
Rate= - answerIP + DRP + LP + PRP + CRP
Par value - answerstated face value of the bond. Generally the amount borrowed and
repaid at maturity.
Often $1000 or $5000
Coupon rate - answerstated interest rate on the bond. Multiply by par value to get dollar
coupon payment. Usually fixed
Maturity date - answerdate when the par value will be repaid to investors. Note that
value declines each year after issue.
