FIN 320 Smartbook Chapter 6

What is a real rate of return?

-it is a rate of return that has been adjusted for inflation -it is a percentage change in buying power

What are the cash flows involved in the purchase of a 5 year zero coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent

Pay $800 today and receive $1,000 at the end of 5 years

A limitation of bond ratings is that they ______

focus exclusively on default risk

If a bond is selling at a discount from its par value, the YTM must be _______ the coupon rate

greater than

a corporate bond's yield to maturity

is usually not the same as a bond's coupon rate, changes over time

What is the nominal rate of return on an investment?

it is the actual percentage change in the dollar value of an investment unadjusted for inflation

the bonds of a firm in financial distress may have a market value that is _______ than the face value at maturity

less

when interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ______

increases

the degree of interest rate risk depends on

the sensitivity of the bond's price to interest rate changes

T/F longer - term bonds have greater interest rate sensitivity because a large portion of a bond's value comes from the face amount

true

Most of the time, a floating-rate bond's coupon adjusts ____

with a lag to some base rate

What four variables are required to calculate the value of a bond?

yield to maturity, coupon rate, par value, time remaining to maturity

ABC co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?

$60 in interest at the end of each year for 10 years and a $1,000 repayment of principal at the end of 10 years

If you are holding a municipal bond that is trading at par to yield 6%, by how much will your after-tax yield change if your federal income tax bracket increases from 15% to 20%. Assume there are no state or local taxes

0%

If you are in the 20% tax bracket, what is your after-tax yield on a par value municipal bond yielding 5%? Ignore state and local taxes.

5%

crossover bonds can also be called ________ bonds

5B

Which of the following are bonds that have actually been issued?

A put bond, a convertible bond, a CoCo bond

What are crossover bonds?

Bonds that have both an investment grade and a junk bond rating

What are "fallen angel" bonds?

Bonds that have dropped from investment grade to junk bond status

T/F The higher the coupon rate, the greater the interest rate risk, all other things being equal

False

the sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?

Time to maturity, coupon rate

T/F Low-grade bonds may not be rated by major rating agencies

True

What are the two unique features of a U.S. federal government bond?

U.S. treasury issues are considered to be default free, U.S. treasury issues are exempt from state income taxes

What is a corporate bond's yield to maturity (YTM)?

YTM is the expected return for an investor who buys the bond today and hold it to maturity, YTM is the prevailing market invest rate for bonds with similar features

to find the total bond value, add the present value of the amount paid at maturity to the ________ of the annual coupon payments

annuity present value

as an investor in the bond market, why should you be concerned about changes in interest rates?

changes in interest rates cause changes in bond prices

when interest rates in the market rise, we can expect the price of bonds to _________

decrease

If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ________ $1,000

less than

When using trial and error to compute the yield to maturity (YTM) for 6 percent coupon bond that trades at a premium, the process can be shortened if the initial guess is ______ 6 percent.

lower than

if you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?

the 10 year bond

Junk bonds have the following features

the are rated below investment grade

If you are holding two bonds - one with a 5% coupon rate and the other with an 8% coupon rate - which one is more sensitive to interest rate risk, all other things being equal?

the bond with a 5% coupon rate