FIN 3403 - CH 7 - Bonds and Bond Valuation

A bond that sells for more than face value is what type of bond?

A premium bond

Which rating means that a firm is in a strong position to meet its debt obligations?

AAA

How much can a corporation expect to receive per bond if it sells ten-year zero coupon bonds with a face value of $1000 if the market rate of interest is 9%?

Answer: $414.64 Zero coupon bonds use semi annual compounding: $1000/[1 + (.09/2)] ^20 (Make N=20 because there are 20 periods in a 10 year semi-annual bond)

When an investor sells Avon, the price received is always the?

Bid price

This type of bond protects insurance companies from natural disasters.

CAT bond

This type of bond can be exchanged for shares of stock.

Convertible bond

If the liquidity of a bond increases than the bonds you will what?

Decrease.

A firms bond rating sheds light on its ____________ risk.

Default

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

Higher risk of default

Junk bonds typically have what rating?

If rated at all, they're rated below BBB grade.

Nominal rates are called "nominal" because they have not been adjusted for _____________.

Inflation

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

Inflation premium, real interest rate, and interest rate risk premium.

A bonds you to maturity considers the interest earnings in the change in the bonds price while the current yield considers what?

Interest earnings only

What is the most important source of risk from owning bonds?

Market interest rate fluctuations

Which bond comes first in order of security as defined in the US: -Debentures -Mortgage bonds

Mortgage bonds are first, debentures our second.

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

Not very significant and also less significant than inflation.

The owner of this bond can force issuer to repay prior to maturity at a stated price.

Put bond

A rate of return that has been adjusted for inflation:

Real rate of return

Which is more transparent, the stock market or the bond market?

Stock market

This type of bond is based on financial securities, commodities, or currencies.

Structured note

The amount by which the call price exceeds the par value of the bond is called?

The call premium

Why does a bond's value fluctuate overtime?

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

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

The real rate of return excludes inflation from the nominal rate.

True or false junk bonds are rated less than investment-grade rating?

True

True or false junk bonds have a high probability of default.

True

True or false: a conventional bond pays periodic interest while zeros make no interest payments.

True

True or false: all else equal, the longer the time to maturity, the greater the interest rate risk.

True

True or false: conventional bonds can sell at par, and a discount from par, or at a premium over par while zeros can not.

True

If a $1000 par value bond is trading at a discount, it means that the market value of the bond is (equal to, less than, or more than) $1000.

Its market value is less than $1000.

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?

10%

If you are in the 20% tax bracket, what is your after-tax yield on a par value municipal bond yielding 5%? Ignore state and local taxes.

5%. Interest income from the Muni is exempt from the federal income tax so the after-tax yield equals the before tax yield.

Which of these are required to calculate the current value of a bond? Check all that apply. -applicable market rate -coupon rate -par value -Price at the time of bond issue -Time remaining to maturity

Applicable market rate Coupon rate Par value Time remaining to maturity

What is the difference between debt and equity?

Equity is publicly traded while debt is not.

Long-term bonds have greater interest rate sensitivity because a large portion of a bonds value comes from the $1000 _______ ________.

Face amount.

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%?

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

Which of the following variables are required to calculate the value of a bond? Check all that apply. -original issue price of bond - remaining life of bond -market yield -coupon rate

Remaining life of bond, market yield, coupon rate.

Which bond is not greatly affected by small changes in interest rates? Choose short-term or long-term.

Short term

Name three important features of treasury notes and bonds:

They are highly liquid, default-free, and taxable on the state or local level but not the federal level.

Three vehicles the US government issues to borrow money:

Treasury notes, treasury bonds, and treasury bills.

A bond has a quoted price of $984.36, a face value of $1000, semi-annual coupon of $20, and a maturity of 10 years. Match its current yield and it's YTM below. YTM Current Yield 4.06% 4.19%

YTM= CY=

How is an APR computed?

(Rate per period X Number of periods in a year) - 1

What will your after-tax you'll be on a corporation bond that is currently priced to yield 7% if you are in the 25% tax bracket?

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

Which of the following are common protective covenants? -The firm cannot merge with any other firm -The firm is pledge assets to other lenders -The firm must limit dividends to equity holders -The firm must maintain working capital at or above a specified level -The firmest issue additional long-term debt within a specified.

-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

Name six factors that determine the yield on a bond.

-expected future inflation -default risk -Real rate of return -taxability -interest rate risk - liquidity

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

The bid price and the asked price.

Which of these correctly identify differences between Treasury bonds and corporate bonds? Check all that apply. -Treasury bonds are issued by the US government will corporate bonds are issued by corporations. -Treasury bonds do not offer any tax benefits to investors but corporate bonds do. -Treasury bonds offered to certain tax benefits to investors the corporate bonds cannot offer. -Treasury bonds are free of default risk while corporate bonds are exposed to default risk.

1,3,4

A corporate bonds yield to maturity can do two things:

1. Change over time 2. Can't be greater than, equal to, or less than the bonds coupon rate

Name two features of municipal bonds:

1. They are exempt from federal taxes 2. They are issued by state and local government's

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

11.11%. Current yield equals annual amount divided by PV (aka Price of bond). First myltiply .10 X $1000 to get payment. It's already annualized at $100. So, $100/$900= .11111 =11.11%

What is the after-tax yield on a US treasury bond using 7% if you are in the 20% tax bracket?

5.6% .07 X (1- 0.2) = 5.6%

If the rate of inflation is 3% and the real rate of return is 5%, the nominal rate is approximately what percent?

8% To find nominal rate simply add inflation to the real rate.

The term for the number of years until the face value of a bond is due to be paid is:

Bond's time to maturity

Which three of the following common shapes for the term structure of interest rates? -v-shaped -downward sloping -upward sloping -humps

Downward sloping, upward sloping, and humped. (P 226)

True or false: zero coupon bond make interest payments.

False

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

It will increase.

In general, a corporate bonds coupon rate?

It's fixed until the bond matures.

A market is considered transparent if?

It's prices and trading volume are easily observed

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

Negative

The reason that interest rate risk is greater for long-term bonds than for short-term bonds is that the change in rates has a greater effect on the present value of ____ value than on the present value of the ____________ payments.

Par, coupon

Name three institutions that issue bonds that are traded in the bond market.

Public corporations, the federal government, state governments.

What are the three components of the treasury of curve?

Real rate of return, expected future inflation, and the interest rate risk premium.

If a given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ___________ rate.

Real rate.

Which of the following are usually included in the bond's indenture? -The bond's rating -The names of the bondholders -The repayment arrangements -The total amount of bonds issued

Repayment arrangements and total amount of bonds issued.

Which of the following are usually included in a bond's indenture? -The repayment arrangements -The name of bondholders -The bonds rating -The total amount of bonds issued

The repayment arrangements and the total amount of bonds issued.

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

They will be the par value of $5000.

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

7%. The nominal rate is the observed rate, in this case the appreciation is the observed rate. It includes inflation. (P 223)

Which of these is included in the calculation of a bonds yield to maturity? Check all that apply. -coupon rate -current price -par value -Number bonds issued

Coupon rate, current price, and par value.

The price at which the dealer is willing to sell is called:

The ask price

To a false: all else equal, the lower the coupon rate, the greater the interest rate risk.

True