Ch.6&7 finance homework

YTM—yield to maturity.

= This is the rate of return you should expect to earn on the bond if you buy it for its market price today and hold it until the maturity date.

sinking fund provision

A bond contract feature that requires the issuer to retire a specified portion of the bond issue each year is called a

Default

A bond issuer is said to be in (BLANK) if it does not pay the interest or the principal in accordance with the terms of the indenture agreement or if it violates one or more of the issue's restrictive covenants.

new issue

A bond that is issued for the first time is called a

Call provision

A bond's (BLANK) gives the issuer the right to call, or redeem, a bond at specific times and under specific conditions.

PAR VALUE

A bond's (BLANK) refers to its face value and the amount of money that the issuing entity borrows and promises to repay on the maturity date

Risk

A friend comes to you and asks you to invest in his business instead of investing in Treasury bonds. You think he has a good business model, so you tell him you are willing to invest as long as the expected return on the investment is at least four times the return you would have received on the Treasury bonds. Determine which of these fundamental factors is affecting the cost of money in the scenario described:

"maturity" date

All of the principal of the loan paid on the last day of the bond =

true

An upward-sloping yield curve is often referred to as a "normal" yield curve, whereas a downward-sloping yield curve is often referred to as an inverted or "abnormal" yield curve. True or false?

MRP

As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because interest rate changes are uncertain, this premium is added as a compensation for this uncertainty.

US government bonds usually have the lowest yields in the bond markets

Based on your understanding of bond ratings and bond-rating criteria, which of the following statements is true?

Higher inflation expectations increase the nominal interest rate demanded by investors.

Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?

True

Bonds are an interest-only loan. t/f

7-15-2005

Bridge Bonds Series A Dated 7-15-2005 4.375% Due 7-15-2055 @100.00 - what is the issuing date of this bond?

Yes

Can the real interest rate ever be negative?

Treasury Bonds

Fixed-income securities consist of debt instruments and preferred stock. Bonds are debt securities in which a borrower promises to pay a specified interest rate and principal at a future date. Which of the following types of bonds have the least default risk? A: Corporate B: Treasury Bonds C: Municipal

is less than its par value of $1,000.

For a 10% $1,000 coupon bond, when the market interest rate is greater than 10%, the value of the bond

more affected by changes in the market rate than a 1-year bond.

For a 10%, $1,000 coupon bond, a longer term bond (say, 15 years) is:

OUTSTANDING bond.

If a bond is selling for a price much lower than its par value, it is most likely that the bond is an

EAR

If the bond has annual coupons, then the YTM will be expressed as an ______ = Effective annual rate.

APR

If the bond has semi-annual coupons, (every 6 months) then the YTM will be expressed as an ______ with semi-annual compounding.

a zero coupon bond

If the price of the bond is initially discounted and offers no coupon payments, the bond is called

A. Walmart B. Corporate

In July 2009, Walmart sold 100 billion yen of five-year samurai bonds. Lead managers in the deal were Mizuho Securities, BNP Paribas, and Mitsubishi UFJ Securities. A: Who is the issuer of the bonds? B: What type of bonds are these?

true

Interest rates on short-term maturities are lower than rates on long-term maturities.

(1) purchase a portion of the debt in the open market or (2) call the bonds if they contain a call provision.

Issuers can gradually reduce the outstanding balance of a bond issue by using a sinking fund account into which they deposit a specified amount of money each year. To operationalize the sinking fund provision of an indenture, issuers can

r* real risk free rate

It changes over time, depending on the expected rate of return on productive assets exchanged among market participants and people's time preferences for consumption.

DRP

It is based on the bond's rating; the higher the rating, the lower the premium added, thus lowering the interest rate.

Rrf= nominal risk-free

It is calculated by adding the inflation premium to r*

Seasoned issues.

Johnson, LLC's bonds have exhibited a substantial trading volume in the past few years. Its bonds would be referred to as a _________,

false

Nominal interest rate shows you a more accurate rate of return than the real interest rate.

outstanding bonds or seasoned issues.

Once they are traded in the bond markets, they are called

IP

Over the past several years, Germany, Japan, and Switzerland have had lower interest rates than the United States due to lower values of this premium.

Will + would-like

Remember, a bond's coupon rate partially determines the interest-based return that a bond ______ pay, and a bondholder's required return reflects the return that a bondholder _______ receives from a given investment.

true

T/F: At maturity: both bonds have to sell for face value or $1,000

True

T/F: If you are a company: you want to always have a AAA rating or an investment grade.

coupon rate

The _____ ______ itself is always expressed as an annual number, no matter whether payments are annual, semi-annual, etc. (see next example) = 8% of 1000 = 80

market interest rates

The default risk premium is an important contributor in determining what happens to which of the following?

the higher its expected return will be

The higher the risk of a security

true

The principal of a bond is more commonly called the par value or the face value T/F

bond issuer

_____ = The company that issues or sells the bond

Bond holder

______ = is the company, corporations or individuals

discount

_______ = means the bond will increase in value if yield stays constant

true

the greater the default risk, the higher the default risk premium.

triple A

these bonds have least amount of risk and have a lower yield to maturity, these bonds are of good quality

True

true or false: A AAA-rated bond has less default risk compared to a BB-rated Bond

true

true or false: the yield on a AAA-rated bond will be lower than the yield on a AA-rated Bond

discount bond*

when the Coupon rate < yield to maturity, it is a _____ ____

Call provision

Which feature of a bond contract allows the issuer to redeem a bond issue immediately in its entirety at an amount greater than par value prior to maturity?

Real interest rates = nominal interact rates - inflation

Which of the following statements is true regarding real and nominal interest rates?

Rcbond = r* + IP+ DRP + LP + MRP - Answer: 2.8% + 4.57% + 1.95%+ .60% = 9.82%

The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 5% per year for each of the next four years and 4% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t - 1)%, where t is the security's maturity. The liquidity premium (LP) on all Sacramone Products Co.'s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): -. Sacramone Products Co. issues seven-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average.

yield curve

The term structure of interest rates is shown graphically with the:

how securities that are similar in every other way but have different maturities and have different yields

The term structure of interest rates shows:

false

The yield curve for corporate bonds tends to have a shape similar to that for Treasury securities, but interest rates on corporate bonds are at lower levels because corporate yields include smaller default risk and liquidity premiums than do Treasury yields. True or false?

senior mortgage bonds

These bonds are backed by real estate holdings and equipment, and if a company goes bankrupt, the collateral can be sold off to compensate for the default. These bonds, more so than other collateralized securities, have prior claims over assets.

subordinated debentures

These bonds are considered the riskiest of all corporate bonds and thus offer the highest interest rates.

debentures

These bonds are traded in the bond markets based on investors' belief that the issuer will not default on the repayment. These bonds have no collateral and usually offer higher yields.

default risk premium DRP

This is the premium added as a compensation for the risk that an investor will not get paid in full.

liquidity risk premium LP

This is the premium added to the equilibrium interest rate on a security that cannot be bought or sold quickly enough to prevent or minimize loss.

inflation premium = IP

This is the premium added to the risk-free rate that reflects the average sustained increase in the general level of prices for goods and services expected over the security's entire life.

maturity risk premium = MRP

This is the premium that reflects the risk associated with changes in interest rates for a long-term security

nominal risk-free rate =Rrf

This is the rate for a riskless security that is exposed to changes in inflation.

real risk free rate = r*

This is the rate on short-term US Treasury securities, assuming there is no inflation.

LP

This premium is added when a security lacks marketability, because it cannot be bought and sold quickly without losing value.

true

True or false: Interest rates on medium-term maturities are higher than rates on long- and short-term maturities

When interest rates are higher than they were when the bonds were issued

Under what circumstances would a firm be more likely to buy the required number of bonds in the open market as opposed to using one of the other procedures?

$1,000

What is the value of a 10-year 10% $1,000 bond when the market interest rate is 10%?

$1,433

What is the value of a 12-year 10% $1,000 bond when the market interest rate is 5%?

$708

What is the value of a 15-year 10% $1,000 coupon bond when the market interest rate is 15%?

AT PAR

When the bond's coupon rate is equal to the bondholder's required return, the bond's intrinsic value will equal its par value, and the bond will trade

EXCEED

When the bond's coupon rate is greater than the bondholder's required return, the bond's intrinsic value will (BLANK) its par value, and the bond will trade at a premium.

DISCOUNT

When the bond's coupon rate is less than the bondholder's required return, the bond's intrinsic value will be less than its par value, and the bond will trade at

This is known as liquidation.

When the company shuts down, it closes all of it's stores and sells its merchandise.

6-month

When valuing a semiannual coupon bond, the time period variable(N) used to calculate the price of a bond reflects the number of (BLANK) periods remaining in the bond's life.

Callable bonds

Which type of bonds offer a higher yield? Callable bonds or non-callable bonds

Inflation Premium (IP) + default risk premium (DRP) + liquidity premium (LP) + maturity risk premium (MRP)

long term corporate have ________________ (all 4)

Inflation Premium (IP) + maturity risk premium (MRP)

long term treasury bills have ____ + _____

r = required return on a debt security

r = r* + IP + DRP + LP + MRP. this is the formula for _____

Term structure

relationship between interest rates (or yields) and maturities.

Inflation Premium (IP) + default risk premium (DRP) + liquidity premium (LP)

short term corporate have ___ + _____ + ____

Inflation Premium (IP)

short term treasury bills have only ____