Question

Explain what a call provision enables bond issuers to do. Why would bond issuers exercise a call provision?

Define a discount bond and a premium bond. Provide examples of each.

Describe the relationship between interest rates and bond prices.

Describe the differences between a coupon bond and a zero coupon bond.

Answer 1

And 1)A call provision is a stipulation on the contract for a bond—or other fixed-income instruments—that allows the issuer to repurchase and retire the debt security.

call provisions on bonds are exercised by the issuer when overall market interest rates have fallen. ... In other words, the company can refinance its debt when interest rates fall below the rate being paid on the callable bond.

Ans 2) Premium Bond

A bond that is trading above its par value in the secondary market is a premium bond. A bond will trade at a premium when it offers a coupon (interest) rate that is higher than the current prevailing interest rates being offered for new bonds. This is because investors want a higher yield and will pay for it. In a sense they are paying it forward to get the higher coupon payment.

For example, a bond that was issued at a face value of $1,000 might trade at $1,050 or a $50 premium. Even though the bond has yet to reach maturity, it can trade in the secondary market.

Discount Bond

A bond currently trading for less than its par value in the secondary market is a discount bond. A bond will trade at a discount when it offers a coupon rate that is lower than prevailing interest rates. Since investors always want a higher yield, they will pay less for a bond with a coupon rate lower than the prevailing rates. So they are buying it at a discount to make up for the lower coupon rate

For example, a bond with a $1,000 face value that's currently selling for $95 would be a discounted bond. Since bonds are a type of debt security, bondholders or investors receive interest from the bond's issuer.

Ans 3) The Inverse Relationship Between Interest Rates and Bond Prices. Bonds have an inverse relationship to interest rates; when interest rates rise, bond prices fall, and vice-versa.

Ans 4) A zero coupon bond generates gains from the difference between the purchase price and the face value while a coupon bond produces gains from the regular distribution of coupon/interest. Zero coupon bonds are issued at a deep discount and repaid the face value at maturity.