Chapter 7: Interest rates and Bond Valuation
Approximate real rate of interest formula
bill rate - inflation rate
A market is considered transparent if _____.
its prices and trading volume are easily observed
If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is _______ $1,000.
less than
What is a premium bond?
A bond that sells for more than face value
Match each of these bonds with their characteristics:
-CAT bond: protects insurance companies from natural disasters -Convertible bond: can be exchanged for shares of stock -Put bond: owner can force issuer to repay prior to maturity at a stated price -Structured note: based on financial securities, commodities, or currencies
What is a real rate of return?
-It is a rate return that has been adjusted to remove inflation -It is a percentage change in buying power -An inflation rate measures changes in buying power
Place the following bonds in order of security as defined in the US
-Mortgage bonds -Debentures
Which of the following are usually included in a bond's indenture?
-The total amount of bonds issued -The repayment arrangements
Current Yield Formula
Current yield = annual coupon income/price
What is a bond's current yield?
Current yield = annual coupon payment / current price
What is the definition of a bond's time to maturity?
It is the number of years until the face value is paid off
When interest rates in the market rise, we can expect the price of bonds to ______.
decrease
What is the present value of the annual interest payments on a 20-year, $1,000 par value bond with a 5% coupon paid annually, if the yield on similar bonds is 10%?
pv of coupons=C*((1-(1/1+r^t)/r) = 425.68
If you own corporate bonds, you will be concerned about interest rate risk as it affects ___.
the market price of the bonds
What is the asked price?
the price at which the dealer is willing to sell
Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?
-the bid price -the asked price
If you purchase a bond costing $1,143 with a par value of $1,000 that pays a semi-annual coupon of 5%, how much will each coupon payment be?
$25
If you invest in a $1,000 corporate bond that has a 9% coupon and makes semi-annual payments, you can expect to receive _____.
$45 every 6 months. .09 /2 = .045 1000 * .045 = 45
A firm decides to raise money by issuing 5 million bonds with a par value of 5,000 each for 10 years at a coupon rate of 7 percent. At the time of the issue, the bonds were sold for 5,500 each. What will the par value of the bonds be in year 5?
$5,000 per bond
a bond pays annual interest payments of $50, has a par value of $1000, and a market price of $1200. how is the coupon rate computed?
$50/$1000
Which of the following are common protective covenants?
-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
Which of these correctly identify differences between US treasury bonds and corporate bonds?
-Treasury bonds are issued by the US government will corporate bonds are issued by corporations. -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.
A corporate bond's yield to maturity
-changes over time -can be greater than, less than, or equal to the bond's coupon rate
Which of these is included in the calculation of a bond's yield to maturity?
-coupon rate -current price -par value
Which of the following variables are required to calculate the value of a bond?
-coupon rate -market yield -remaining life of bond
All junk bonds typically have which of these features?
-less than investment-grade rating -high probability of default
the reason that interest rate risk is greater for _____ term bonds than for _____ term bonds is that the change in rates has a greater effect on the present value of the _____ than on the present value of the _____.
-long -short -face value -coupon payments
Which of the following are features of Municipal bonds?
-the interest on municipal bonds is exempt from federal taxes -they are issued by state and local government
when the US government wants to borrow money for the long-term (more than one year) it issues:
-treasury notes -treasury bonds
How is a zero coupon bond different from a conventional bond?
-zero coupon bonds make no interest payments -zero coupon bonds are always issued at a discount
What is the effective annual yield for a bond that pays interest semiannually and has a quoted yield to maturity of 10 percent?
10.25% [1+(.10/2)]^2-1
If the rate of inflation is 3 percent and the real rate of return is 9 percent, the nominal rate is approximately ______ percent.
12
Use your calculator to find the YTM on a 20 year, $1,000 par value bond that pays coupons of 4.5% semi-annually and currently sells for $1104.89.
3.75%
If you are in the 15 percent federal tax bracket, what will be your after tax yield on a US treasury bond that is currently priced at par and yielding 5 percent?
4.25%
f 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.
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 = 4.19% Current yield = 4.06%
Real rate of interest formula
[(1 + bill rate) / (1 + inflation rate)] -1
A bond's yield to maturity considers the interest earnings and the change in the bond's price while the current yield considers ____.
interest earnings only.
What is the nominal rate of return on an investment?
it is the rate that has not been adjusted for inflation