Finance Chapter 8

ABC company issued $1 million worth of 6% annual coupon bond that mature in 10 years. The face value is $1000 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 $1000 repayment of principal at the end of 10 years.

What is the present value of the annual interest payments on a 10 year $1000 part value bond with a coupon rate of 10% paid annually, if the yield on somewhere bonds is 9%?

$641.77

A bond pays annual coupon payments of $50, has a face value of $1000, and a market price of $1200. How is the coupon rate computed?

50/1000=.05 or 5%

What will your after-tax yield be on a corporate bond that is currently trading at par and yielding 8% if you're in the 20% tax bracket?

6.4%= .08*(1-.2)

What is a premium bond?

A bond that sells for more than face value

Which two prices can be found in the Wall Street Journal's daily treasury bond listing?

Bid price and ask price

A corporate bonds yield to maturity______

Changes over time and can be greater than, equal to, or less than the bonds coupon rate.

What are the three components of the treasury yield curve?

Expected inflation, the interest rate risk premium, and the real rate of return.

Cording to the approximation formula for the normal rate of return (r), the nominal rate will ________ if inflation (h) increases.

Increase

What are some reasons why the bond market is so big?

Various state and local government also participate in the bond market, many corporations have multiple bond issues outstanding, and the federal government borrowing activity in the bond market is enormous.

What is the effective annual yield for a bond that pays interest semiannually and has a quoted yield to maturity of 10%?

10.25% [1+(.10/2)]^2-1

What does a bond rating of C typically indicate?

The issuer is in default

Why does a bond value fluctuate over time?

The coupon rate in par value are fixed, while market interest rates change

Which of the following are common shapes for the term structure of interest rates?

Downward sloping, upward sloping, and flat.

The promised yield and the expected return for a risk free security will be:

Equal

What is the definition of a bonds time to maturity?

It is the number of years until the face value is paid off.

What will happen to the default risk premium during periods of economic uncertainty?

It will increase.

What is the coupon rate?

The coupon rate determine the periodic interest payments made to investors.

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

The coupon rate, applicable market rate (market yield), and the time remaining to maturity (remaining life of a bond).

Why is the bondmarket less transparent than the stock market?

Many bond transactions are negotiated privately

What information is needed to compute a bonds yield to maturity?

The bonds current price, the coupon rate, and the time to maturity

If the present value of the interest payments on a bond is $320 in the present value of the par value to be paid on the 30th $900, the total value of the bond must be:

$1,220

What is the principal amount of a loan if the monthly payment on a 30 year mortgage is $1600? Assume an annual interest rate of 6%, compounded monthly.

$266,866.58

What is the present value of $1000 to be received in 10 years if the interest rate is 12% compounded semiannually?

$311.80

If you invest in a $1000 corporate bond that has a 9% coupon and mix semi annual payments, you can expect to receive______ each six months.

$45

What is the value of a zero coupon bond that matures in 15 years if it promises to pay $5000 at maturity, assuming an interest rate of 7.5% compounded annually?

1689.83= $5000/(1.075)^15

If you were in the 20% tax bracket what is your after-tax yield on a par value municipal bond yielding 5%?

5%

What is the difference between the quoted yield and the effective yield?

The quoted yield does not adjust for compounding, while the effective yield adjust for compounding

How is the real rate of return different from the normal rate of return?

The real rate of return adjust the normal rate to remove the effects of inflation.

What are the three components of a nominal rate of return?

The real rate of return, compensation for the inflation effect on the original investment, compensation for the inflation effect on investment earnings

The sensitivity of a bonds price to enter three changes depending on which of the following two variables?

Time to maturity and the coupon rate

Which of the following terms apply to a bond?

Time to maturity, coupon rate, par value

What is the coupon rate on a bond that has a par value of $1000, a market value of $1100 and a coupon interest payment of $100 per year?

Coupon Rate=$100/$1000=10%

A conventional bonds cash flow's consist of:

Coupon interest payments and repayment of the bonds par value at maturity.

If the liquidity of a bond increases then the bonds yield will:

Decrease

When interest rates in the market rise, we can expect the price of bonds to:

Decrease

What is a discount bond?

Discount bonds are bonds that sell for less than the face value

All junk bonds typically have which of these features?

High probability of default, and a less than investment grade rating.

Inflation premium is the additional return demanded by investors to compensate for:

Inflation

What does a bond rating reflect?

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

What does the AAA rating of the sign by S&P mean?

The firm is in a strong position to meet it's debt obligations

Which three components determine the shape of the term structure of interest rates?

The inflation premium, the real interest rate, the interest rate risk premium

Which of the following are features of municipal bonds?

The interest on municipal bonds is exempt from federal taxes, and they are issued by state and local government's.

If you are in the 15% tax bracket, what will be your after-tax yield on a US treasury bond that is currently priced at par and yielding 5%?

.05*(1-.15)= 4.25%

What is the current yield on a $1000 par value bond that sells for $900 if the coupon rate is 10%?

11.11%= (.10*$1000)/$900

Which of these correctly identify differences between US treasury bonds in corporate bonds?

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

What are municipal bonds?

Bonds that have been issued by state or local governments.

How has TRACE improved transparency in the corporate bond market?

Corporate bond dealers are required to report trade information through TRACE

What are the sources of information for generating bond ratings?

Information from the corporation being rated, and information collected by the bond rating agency.

Which is the promised yield on a bond?

It is the yield based on the current price and expected cash flows, assuming no default

How significant is the real rate of return in determining the shape of the term structure of interest rates?

Not very significant, and less significant than inflation

Which of the following institutions issues bonds that are traded in the bond market?

State governments, public corporations, and the federal government

What are some features of the OTC market for bonds?

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

The degree of interest rate risk depends on:

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

What is a corporate bonds yield to maturity?

The yield to maturity is the prevailing market interest rate for bonds with similar features. It is also the expected return in for an investor who buys the barn in order to maturity.

What are three important features of treasury notes and bonds?

They are default free, taxable and highly liquid

What does TIPS stand for?

Treasury inflation protected securities

The US government borrows money by issuing

Treasury notes and treasury bonds

What is a Bonds to maturity?

Yield to maturity is the expected return on a bond that is held until it matures

How is a zero coupon bond different from a conventional bond?

Zeros make no interest payments, and are always issued at a discount.

How is investing in US treasury bonds different from investing in corporate bonds?

Interest from US treasuries is exempt from taxes at the state level but corporate interest is not, and treasury issues have virtually no default risk.

What is a real rate of return?

It is a rate of return that has been adjusted for inflation, and is a percentage change in buying power.

Which of the following are true about a bonds face value?

It is also known as the par value and it is the principal amount repaid at maturity

What is the nominal rate of return on an investment?

It is the actual percentage change in the dollar value of an investment.

A market is considered transparent if

It's prices and trading volume are easily observed.

A firm decides to raise money by issuing $5 million bonds with a par value of $5000 each for 10 years and a coupon rate of 7%. At the time of issue, the bonds are sold for $5500 each. What will the par value the bonds be in the year five?

$5000

A bond yield to maturity what exceed its current yield when the bond is selling at:

A discount