LearnSmart Chapter 5 Conceptual Questions

If the PV of the interst payments on a bond is $320 and the PV of the par value to be paid at maturity is $900, the total value of the bond is ______.

$1,220. $320 + $900 = $1220

What is the principal amount of a loan if the monthly payment on a 30 year mortgage is $1,600? Assume annual interest rate of 6%, compounded monthly.

$266,866.58 PMT = 1600 N = 30 * 12 i = 6/12 = 0.5 PV = -266866.58303

A corporation issues 50K bonds at $1K each. The bonds mature in 5 years and have a coupon rate of 7%. What is the total annual interest expense for the corporation?

$3.5 million. $1000 * 7% = 70 interest expense p/bond * 50,000 bonds = $3.5M

What is the PV of $1K to be received in 10 years if the interest rate is 12%, compounded semiannually?

$311.80 FV = 1000 N = 20 i = 6 PV = -311.80473

How much can a corporation expect to receive per bond if it sells 10 year zero coupon bonds with a face value of $1K if the market rate of interest is 9%? (Zero coupon bonds are semiannual)

$414.64 FV = 1000 N = 20 i = 4.5 PV = -414.64

What is the PV of 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 NOT $574.32; that is the PV of the face value of the bond. Looking for PV of annuity due; both add up to par value ($1,000) of bond.

If you invest in a $1,000 corporate bond that has 9% coupon rate and makes semiannual payments, you can expect to receive _______ every 6 mo.

$45 every 6 months FV = 1000 PMT = 9*1000/2 = 45 N = 6 PV = 1270 $1270 - $1000 = $270/6 = $45 every 6 months

What is the value of a bond if the PV of interest cash flows is $200 and the PV of the par value to be received when the bond matures is $750?

$950. $200 + $750 = $950 PV of interest cash flows + PV of par value at maturity = total value of bond

What is a real rate of return?

1) % change in buying power 2) Rate of return that has been ADJUSTED for inflation (which is why you subtract inflation rate from real rate to get nominal rate, which is NOT ADJUSTED for inflation)

Bond's face value:

1) Also known as par value 2) Principal amount repaid at maturity

Investing in U.S. Treasury bonds are different from investing in corporate bonds because:

1) Interest from U.S. T. is exempt from taxes at state level but corporate interest is not 2) Treasury issues have no default risk

Which are features of municipal bonds?

1) Issued by state & local governments 2) Interest is exempt from state taxes, but is sometimes taxable at the state level.

Three important features of Treasury notes & bonds:

1) Taxable 2) Highly liquid 3) Default-free NOT tax free (interest paid on Treasury securities is taxable at federal level)

Which are accurate?

1) Unlike dividend omissions to equity holders, unpaid debt obligations can lead to bankruptcy. 2) Equity represents ownership interest; debt does not. 3) Interest payments on debt are tax deductible but divident payments on stock are not. FALSE: Equity is publicly traded; corporate debt is not.

A corporate bond's YTM:

1) changes over time 2) can be greater than/equal to/less than bond's coupon rate

What is the EAY for a bond with 10% YTM that makes semiannual interest payments?

10.25%. 10 down(NOM%) 2 down(P/YR) down(EFF%) = 10.25% * Don't forget to clear calculator to 1 p_yr

If you are in the 15% tax bracket, what's your after tax yield on a US Treasury bond that is currently priced at par and yielding 5%?

4.25%. Yield * (1-tax bracket rate) = after tax yield 0.05 * (1-0.15) = 4.25%

What is the EAY for a bond with 7% YTM that makes semiannual interest payments?

7.12%. 7 down(NOM%) 2 down(P/YR) down(EFF%) = 7.12% * Don't forget to clear calculator to 1 p_yr

What is a premium bond?

A bond that sells for more than face value.

Nominal rate of return:

Actual % change in the $ value of an investment.

Blanket mortgage bond:

All real property is owned by the borrower.

Debenture bond:

An unsecured bond.

APR:

Annual Percentage Rate

Bond's current yield =

Annual coupon payment/current price

Which two prices can be found in a daily Treasury bond listing?

Asked & bid price

Which has higher value, bid price quote or asked price quote?

Asked price quote is higher (represents how much an investor must pay to buy the bond).

Mortgage security bond:

Associated with real estate security.

What is a corporate bond's YTM? A) Yield earned if bond is sold immediately in market B) Expected return for investor who buys bond today & holds it to maturity C) Another term for bond's coupon rate D) Prevailing market interest rate for bonds with similar features

B & D NOT coupon rate; coupon rate determines period interest payments made to investors.

Structured note

Based on financial securities, commodities, or currencies

What is the nominal rate of return on an investment? A) % change in dollar value of investment adjusted for inflation B) Average rate of return earned by similar investments C) Actual % change in the $ value of an investment D) Rate of return earned in excess of the average rate earned by similar investments

C) Actual % change in the $ value of an investment

What is the definition of a bond's time to maturity? A) Number of years until bond is sold by bondholder B) Period of time since bond was issued C) Number of years until face value is paid off D) Number of years the corporation is expected to be in existence

C) Number of years until face value is paid off

Which of the following allows a company to repurchase a bond?

Call provision

Convertible bond

Can be exchanged for shares of stock

Collateral trust bond:

Common stock is held by the borrower.

What do you use to calculate the value of a bond?

Coupon rate (PMT), market yield (YTM), remaining life of bond (N) NOT original issue price of bond (not relevant in calculating current price)

What risk is addressed in bond ratings?

Default risk

YTM:

Expected return on a bond that is held until it matures.

A bond's value is not affected by changes in the market rate of interest? T/F

False

Accrued interest:

Interest that was earned but not received yet.

Multi-year typical bond's coupon:

Is a fixed annuity payment (coupons are paid in regular amounts at regular intervals)

How to finance deficits:

Issue bonds

What happens to a bond's time to maturity as the years go by?

It declines.

What is most important source of risk from owning bonds?

Market interest risk fluctuations

Put bond

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

CAT bond

Protects insurance companies from natural disasters

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

Real rate of return adjusts nominal rate to remove the effects of inflation. NOT real rate of return adds inflation to the nominal rate.

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

Repayment arrangements and total amount of bonds issued. NOT names of bondholders or bond rating (ratings are established independently by debt rating agencies).

Which institutions issue bonds traded in the bond market?

State & federal gvt, public corporations

Which shape does the term structure of interest rates usually have?

Upward sloping

How are zero coupon bonds different from conventional bonds?

Zeroes are issued at a discount (because PV < par/future value) and zeroes make no interest payments (PMT)

Bonds have:

coupon rates, par values, time to maturity

Junk bonds have:

high probability of default & less than investment-grade rating

When interest rates in the market fall, bond values will increase bc the present value of the bond's remaining CF _______.

increases

Inflation premium is the additional return demanded by investors to compensate for:

inflation

In general, a corporate bond's coupon rate ________.

is fixed until the bond matures

A market is transparent if ______.

its prices & trading volume are easily observed

If a par value bond is trading at a discount, the market value of the bond is _______ par value.

less than

If you own corporate bonds, you will be concerned about interest risk as it affects ______.

market price of the bonds

When the term structure of interest rates is downward sloping, ______.

short-term rates are higher than long-term rates