FIN 425 Exam Review

A bond investor face which of the following risk? A. default risk B. interest rate risk C. both default risk and interest rate risk D. none of the above

C

Yield to maturity (YTM)

the rate of return earned on a bond if it is held to maturity

Coupon

the stated interest payment made on a bond

Net present value (NPV)

the sum of the present values of expected future cash flows from an investment, minus the cost of that investment

Maturity

the time at which payment to a bondholder is due

Mortgage

a specific type of loan that is used to buy real estate

Debentures

an unsecured loan certificate issued by a company, backed by general credit rather than by specified assets.

Premium Bond

- Bond price is higher than par value - Coupon rate exceeds yield to maturity - Bond price will decline to par over its maturity

Discount Bond

- Bond price is lower than par value - Yield to maturity exceeds coupon rate - Bond price will increase to par over its maturity

Duration:

-the term for the effective maturity of a bond. -- Used as a more precise proxy for the degree to which an investor is exposed to the interest rate risk.

Floating rate bonds

A floating-rate note is a bond that has a variable interest rate, vs. a fixed-rate note that has an interest rate that doesn't fluctuate. The interest rate is tied to a short-term benchmark rate, such as LIBOR or the Fed funds rate, plus a quoted spread, or rate that holds steady.

Which one of the following bonds is the least sensitive to interest rate risk? A. 3-year; 4 percent coupon. B. 3-year; 6 percent coupon. C. 5-year; 6 percent coupon. D. 7-year; 6 percent coupon. E. 7-year; 4 percent coupon.

B

Which one of the following applies to a premium bond? A. Yield to maturity > current yield > coupon rate. B. Coupon rate = current yield = yield-to-maturity. C. Coupon rate > yield-to-maturity > current yield. D. Coupon rate < yield-to-maturity < current yield. E. Coupon rate > current yield > yield to maturity.

E

Average accounting return (AAR)

an investment's average net income divided by its average book value

Convertible provision

Grants the bondholder the right to exchange the bond for a specific number of shares of common stock. (may benefit both issuer & bondholder)

Current Yield

It is a measure of the annual return if you do not sell the bond.

Face value (par value)

The payment to the bondholder at the maturity of the bond.

Interest rate risk

The risk that arises for bond owners from fluctuating interest rate.

Collateral

something pledged as security for repayment of a loan, to be forfeited in the event of a default.

Payback period

the amount of time required for an investment to generate cash flows sufficient to recover its initial cost

coupon rate

the interest rate that a bond issuer will pay to a bondholder

Discounted payback period

the length of time required for an investment's discounted cash flows to equal its initial cost

Convexity:

the measure for the curvature in the relationship between bond prices and bond yields