Ch. 7 Concept Questions

(7.5b) In general, what are bid and ask prices?

-Bid is the willing to pay for a security -Asked price is the price a dealer is willing to take for a security

(7.3b) What is a junk bond?

Low grade bonds; rated below investment grade

(7.3a) What does a bond rating say about the risk of fluctuations in a bond's value resulting from interest rate changes?

Nothing, they are not dependent

(7.6b) What is the Fisher effect?

The relationship between nominal returns, real returns and inflation

(7.7c) What 6 components make up a bond's yield?

1. real rate of interest + five premiums representing compensation for (1) expected future inflation (2) interest rate risk (3) default risk (4) taxability (5) lack of liquidity

(7.7b) What is the Treasury yield curve?

A plot of yields on Treasury notes and bonds relative to maturity Shape of yield curve reflects the term structure of interest rates.

(7.6a) What is the difference between a nominal and a real return? Which is more important to a typical investor?

Nominal rates are called "nominal" because they have not been adjusted for inflation Real rates are rates that have been adjusted for inflation

(7.5c) What is the difference between a bond's clean price and dirty price?

the quoted price is the clean price, its the price of a bond net of accrued interest; this is the price that is typically quoted the dirty price of a bond is the price of a bond including accrued interest (also known as the full or invoice price); this price is the price the buyer actually pays

(7.5a) Why do we say bond markets may have little or no transparency?

because most trading in bonds takes place over the counter (OTC)

(7.7a) What is the term structure of interest rates? What determines its shapes?

The term structure of interest rates is the relationship between interest rates or bond yields and different terms or maturities. The term structure of interest rates is also known as a yield curve, and it plays a central role in an economy. Long term rates are higher than short term rates- upward sloping; When short term rates are higher- downward sloping; the real rate of interest and the rate of inflation; interest rate risk