Finance 300

True or false: If you invest in a bond that is rated AAA by S&P, you can be reasonably assured that your investment has very little default risk.

True

A limitation of bond ratings is that they ____.

focus exclusively on default risk

As interest rates increase,

present values decrease as does the price of the bond.

As interest rates decrease,

present values increase as does the price of the bond.

If an investment appreciates by 7 percent while the rate of inflation is 2 percent, what is the nominal rate of return?

7%

Which of the following is true about interest rate risk?

All else equal, the lower the coupon rate, the greater the interest rate risk. All else equal, the longer the time to maturity, the greater the interest rate risk.

True or false: The real rate of return will generally be higher than the nominal rate of return.

False

How is investing in U.S. Treasury bonds different from investing in corporate bonds?

Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not. Treasury issues have no default risk.

Which of the following is true about a typical multiple-year bond's coupon?

It is a fixed annuity payment.

What is a real rate of return?

It is a rate of return that has been adjusted for inflation.

What is the nominal rate of return on an investment?

It is the rate that has not been adjusted for inflation.

What are some features of the OTC market for bonds?

OTC dealers are connected electronically. The OTC has no designated physical location.

What are the federal income tax implications of receiving $50 in interest income from a municipal bond versus a corporate bond?

Only the interest on the corporate bond will be taxed.

What does a Moody's bond rating of C typically indicate?

The issuer is in default

Bond Value =

PV of coupons + PV of Par Value

Which of these are required to calculate the current value of a bond?

Par value Time remaining to maturity Applicable market rate Coupon rate

What is the equation for approximating the nominal rate of return?

R = r + h

Which of the following variables are required to calculate the value of a bond?

Remaining life of bond Coupon rate Market yield

What does a bond's rating reflect?

The ability of the firm to repay its debt and interest on time

What is the asked price?

The asked price is the price at which a dealer is willing to sell.

You own two bonds—one with a 5 percent coupon and one with a 6 percent coupon. Which one is more sensitive to interest rate risk, all other things being equal?

The bond with the 5 percent coupon rate is more sensitive.

Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?

Treasury bonds are issued by the US government while corporate bonds are issued by corporations. Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer.

How is investing in U.S. Treasury bonds different from investing in corporate bonds?

Treasury issues have no default risk. Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not.

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

YTM is the expected return for an investor who buys the bond today and holds it to maturity. YTM is the prevailing market interest rate for bonds with similar features.

Yield or Yield to maturity =

Yield to maturity (YTM) is the total return anticipated on a bond if the bond is held until it matures

Coupon rate

annual coupon divided by face value

If the market rate of interest declines

bond values increase.

A corporate bond's yield to maturity ____.

changes over time can be greater than, equal to, or less than the bond's coupon rate

True or false: If you invest in junk bonds, there is a high likelihood that you will earn a very high return.

false

A bond with a BBB rating has a ______ than a bond with an A rating.

higher risk of default

When interest rates in the market fall, bond values are likely to increase because the present value of the bond's remaining cash flows ____.

increased

Current Yield

is the annual interest paid (coupon) by a bond divided by the current market price. Current yield represents the return an investor would expect to earn, if the owner purchased the bond and held it for a year.

Longer-term bonds have greater interest rate sensitivity because a

larger portion of a bond's value comes from the face amount.

The reason that interest rate risk is greater for Blank______ term bonds than for Blank______ term bonds is that the change in rates has a greater effect on the present value of the Blank______ than on the present value of the Blank______.

long; short; face value; coupon payments

The OTC has _____ designated physical location.

no

Discount Bonds

occur when the current market interest rates are higher than the original interest rate of the bond at the time of issuance making the bond trade at a discount or cheaper than its original Par value

Premium Bonds

occur when the current market interest rates are lower than the original rate interest rate of the bond at the time of issuance making the bond trade at a premium or more expensive than its original Par value.

In financial markets the difference between the bid

price and the ask price is known as the spread.

A bond's coupon rate

rate is the stated interest payment made on a bond.

Within the context of financial markets, complete the following equation: Bid − Ask = Bid-Ask

spread

Bond ratings are based on the probability of default risk, which is the risk that ___.

the bond's issuer may not be able make all the required payments

All other things being equal, the lower

the coupon rate, the greater the interest rate risk.

par value (face value)

the principal amount of a bond that is repaid at the end of the term

The degree of interest rate risk depends on ____.

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

coupon

the stated interest payment made on a bond

If YTM = coupon rate,

then par value = Current bond price

f YTM > coupon rate

then par value > current bond price

If a $1,000 par value bond is trading at a premium, the bond is _____.

trading for more than $1,000 in the market