FIN306 Midterm #2

If the price is a discount to par, then the YTM is _________ than the coupon rate

greater

Which will have a higher price? A three year zero coupon bond or a five year zero coupon bond?

A three year zero coupon bond, because the future value is received sooner and the present value is higher

Suppose you purchase a 20-year 8% coupon bond, receive each of the first two semi-annual coupon payments as promised, and then sell the bond immediately after receiving the second payment. If the bond's YTM was 8% at the time you purchased it and remained constant until you sold it, your annualized return on this investment will be: A) 8% B) less than 8% C) greater than 8% D) less than, equal to, or greater than 8%

A) 8%

All else equal, which bond's price has the largest percentage drop when its YTM goes up by 1%? A) A 30-year bond B) A 10-year bond

A) A 30-year bond a long term bond has greater interest rate risk than a short term bond

Each payment for an amortized loan is: A) interest only B) principal only C) a combination of interest and principal

A) a combination of interest and principal

Suppose a bond's YTM is less than its coupon rate. This bond sells at: A) a premium B) a discount C) par

A) a premium

In a bond contract, which of these is another name for the borrower? A) bond issuer B) bond investor

A) bond issuer

Which of these typically stays the same over the life of a bond? A) coupon rate B) yield to maturity

A) coupon rate

Each coupon payment for a bond is: A) interest only B) principal only C) a combination of interest and principal

A) interest only

For a given firm, whom do you expect to require a greater rate of return? A) its stockholders B) its bondowners

A) its stockholders

A stock represents: A) ownership of a firm B) debt of a firm

A) ownership of a firm

Which of these typically changes over the life of a bond? A) price B) face value C) par value

A) price

For a given firm, which do you expect to be a riskier investment? A) purchasing its stock B) purchasing its bonds

A) purchasing its stock

Which do you expect to have a higher YTM? A) a 10-year treasury bond B) a 10-year Alcoa bond C) it depends on the state of the economy

B) a 10-year Alcoa bond

Suppose a bond's YTM is greater than its coupon rate. This bond sells at: A) a premium B) a discount C) par

B) a discount

A bond represents: A) ownership in a firm B) debt of a firm

B) debt of a firm

Suppose you purchase a 20-year 8% coupon bond and receive the first two payments then immediately sell it. If the bond's YTM was 8% at the time you purchased it and 10% when you sold it, you annualized rate of return on this investment will be: A) 8% B) less than 8% C) greater than 8%

B) less than 8%

Think about a credit spread between Baa bonds and treasuries A) this spread will be constant over time B) this spread will change over time

B) this spread will change over time

All else equal, which bond's price has the largest percentage drop when its YTM goes up by 1%? A) A 7% coupon bond B) A 4% coupon bond C) A zero coupon bond

C) A zero coupon bond A low coupon bond has greater interest rate risk than high coupon bonds

For a BOND, which represents promises a firm makes to investors: A) coupon payments B) par value repayments C) both of these D) none of these

C) both coupon payments and par value repayments

A corporate bond is issued by a corporation (such as Alcoa). A treasury bond is issued by the US government. Which of these has interest rate risk? A) corporate bond only B) treasury bond only C) both the corporate bond and the treasury bond

C) both the corporate bond and the treasury bond

Suppose you purchase a 20-year 8% coupon bond, receive each of the first two coupon payments then sell it immediately. If the bond's YTM was 8% at the time you purchased it and 6% when you sold it, your annualized rate of return on this investment will be: A) 8% B) less than 8% C) greater than 8%

C) greater than 8%

Suppose a bond's YTM equals its coupon rate. This bond sells at: A) a premium B) a discount C) par

C) par

Discount bonds have built-in capital gain. What does this mean?

Capital gains happen when a price goes up

Premium bonds have built-in capital loss. What does this mean?

Capital loss is when the price goes down

Which of these is a cash payment from a firm to its stockholders? A) net income B) earnings per share C) revenue per share D) dividend E) all of these

D) dividend

Suppose you purchase a 20-year 8% coupon bond, receive each of the first two semi-annual coupon payments as promised, and then sell the bond immediately after receiving the second coupon payment. If the bond's YTM was 8% at the time you purchased it, your annualized return on this investment will be: A) 8% B) less than 8% C) greater than 8% D) less than, equal to, or greater than 8%

D) less than, equal to, or greater than 8% (we don't know the YTM at the selling point)

Where does a bond most likely appear on a firm's balance sheet? A) top left B) bottom left C) top right D) middle right E) bottom right

D) middle right

For a STOCK, which represents promises a firm makes to investors: A) future dividends B) future stock price C) both of these D) none of these

D) none of these

What is a credit spread or default premium?

Higher YTM to compensate the bondholder for the risk of default

3 major credit agencies are

Standard&Poor's Moody's Fitch Ratings are AAA down to D (default)

Which will have a higher price? A three year zero coupon bond or a three year 4% coupon bond

The three year 4% coupon bond, because the 4% coupon bond pays interest payments; whereas the zero-coupon bond is a pure discount bond

Which will have a higher price? A two year 5% coupon bond or a two year 6% coupon bond?

The two year 6% coupon bond, because the coupon (interest) payments are higher, even though the timing is the same

The difference between bonds based on issuers (treasury vs. Alcoa bond) is called a

credit spread (default risk)

If the price of the bond is at par, then the YTM is _______________ the coupon rate

equal to the coupon rate

The yield curve observed reveals...

expectations of future inflation (expectations of future inflations helps us understand the yield curve)

Since bonds that sell at a premium have built-in capital loss, investor should avoid them and instead buy bonds that sell at a discount. TRUE OR FALSE

false

True or false: bond prices are not sensitive to market-determined interest rates

false

________ is a key driver of all nominal rates

inflation is a key driver of all nominal rates

A YTM is like an "expected return" for a bond. When might a bond investor NOT earn the bond's YTM?

interest rate risk - risk associated with the price of the bond changing (if YTM goes up, price goes down) default risk - risk issuer wont make payments as specified in the contract (not paying the full amount or potentially not at the right time)

2 primary groups of ratings

investment grade (BBB+) speculative grade (BB-)

What characteristics of a bond determine the sensitivity of prices to discount rates (interest rate risk)

length of the bond (long-term or short-term) coupon rate of the bond (high or low rate)

If the price is premium to par, then the YTM is _________ than the coupon rate

less

A firm can choose a coupon rate for its bonds at the time of issuance. Does this mean the firm can save on interest by simply choosing a low coupon rate? yes or no

no

The greater the credit spread, the _____ the bond

riskier

The difference in yield or maturity of bonds from the same issuer is called...

term spread shorter maturities tend to have shorter yields (and vice versa)

TRUE or FALSE Issuing firms tend to set a bond's coupon rate such that it will sell for approximately par value at the time of issuance.

true