FIN: CH 7 Interest Rates and Bond Valuation

The degree of interest rate depends on _______________.

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

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 income tax bracket increases from 15% to 20%. Assume there are no state or local taxes

0%

Place the following bonds in order of security as defined in the U.S

1) Mortgage bonds 2) Debentures

What is a premium bond?

A bond that sells for more than face value

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

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 Treasury bonds are issued by the US gov't while corporate bonds are issued by the corporations

If you invest in a corporate bond, how many times can you expect, in general, to receive interest?

Twice a year

A bond has a quoted price of $984.63, a face value of $1,000, a semi-annual coupon of $20, and a maturity of 10 years. Match its current yield and its YTM below.

YTM= 4.19% Current yield= 4.06%

Why is the bond market less transparent than the stock market?

Many bond transactions are negotiated privately

There is a(n) ________________ relationship between market interest rates and bond values.

Negative

Put bond

owner can force issuer to repay prior to maturity at a stated price

All junk bonds typical have which of these features?

- Less than investment-grade rating - High probability of default

Which of these is included in the calculation of a bond's yield to maturity?

- Par value - Current price - Coupon rate

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

- Par value - Time remaining to maturity - Coupon rate - Applicable market rate

Which of the following terms apply to a bond?

- Par value, - Coupon rate - Time to maturity

Structured note

Based on financial securities, commodities, or currencies

Convertible bond

Can be exchanged for shares of stock

A firm's bond rating sheds light on its _________ risk.

Default

The liquidity premium compensates investors based on a bond's __________________.

Degree of marketability

Cat bond

Protect insurance companies from natural disasters

A market is considered transparent if ______________.

its prices and trading volume are easily observe

A zero-coupon bond is a bond that _______________.

makes no interest payments

What is the present value of the annual interest payments on a 20 year, $1000 par value bond with a 5% coupon paid annually, if the yield on similar bonds is 10%?

$425.68 PV= (.05 X $1000) X (1-1/1.10^20) .10 = $425.68

A bond pays annual interest payments of $50, has a par value of $1,000, and a market price of $1,200. How is the coupon rate computed?

$50/$1000

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

- Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeros cannot. - A conventional bond pays periodic interest whiles zeros make no interest payments

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

- Remaining life of bond - Coupon rate - Market yield

When the US government wants to borrow money for the long-term (more than one year) it issues:

- Treasury notes - Treasury bonds

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

What is a discount bond?

Discount bonds are bonds that sell for less than face value

A bond with a BBB rating has a (higher or lower) risk than a bond with an A rating.

Higher risk of default

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

- Downward sloping - Upward sloping - Humps

What are three important features of Treasury notes and bonds?

- Highly liquid - Default-free - Taxable

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

- Internet 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 are true about a bond's face value?

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

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

- State governments - The federal government - Public corporations

which two prices can be found in the wall street journal's daily treasury bond listing?

- The asked price - The bid price

Which of the following are features of municipal bonds?

- They are issued by state and local governments - The interest on municipal bonds is exempt from federal taxes

Which of the following are common protective covenants?

-The firm cannot merge with any other firm -The firm must limit dividends to equity holders -The firm must maintain working capital at or above a specified level

Which of the following are usually included in a bond's indenture?

-The repayment arrangements -The total amount of bonds issued

What will your aftertax yield be on a corporate bond that is currently priced to yield 7% if you are in the 25% tax bracket?

5.25 (yield) X (1 - tax rate) .07 X (1 - .25) .07 X .75 = 5.25

What is the effective annual rate for a bond with a 7% yield to maturity that makes semi annual interest payments? (hint: 7% annual is 3.5% per 6 month period)

7.12% = (1.035)^2-1 = 7.12%

According to the approximation formula for the nominal rate of return (R), the nominal rate will _________________ if inflation (h) increases.

Increase

A bonds yield to maturity considers the interest earnings and the change in the bonds price while the current yield considers _______________.

Interest earnings only

What is a real rate of return?

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

What is the definition of a bond's time to maturity?

It is the number of years until the face value is due to be repaid

What is the nominal rate of return on a investment?

It is the rate that has not been adjusted for inflation