FIN 320 CH 6
If the rate of inflation is 3% and the real rate of return is 9%, the nominal rate is approximately __ percent
12
What does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
What will happen to a bonds time to maturity as the years go by?
It will decline
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
If you are in the 20% federal income tax bracket, what is you after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes
5% Interest income from munis is exempt from federal income tax
What are three components that influence the Treasury yield curve?
Expected inflation The interest rate risk premium The real rate of return
What is a premium bond?
A bond that sells for more than face value
What are municipal bonds?
Bonds that have been issued by state or local governments
What is bonds current yield?
Current yield = annual coupon payment / current price
When interest rates in the market rise, we can expect the price of bonds to __
Decrease
What is a bonds accrued interest
It is interest that has been earned but not yet received by the current bondholder
A part of the indenture limiting certain actions during the term of the loan are termed ____
Protective covenants
Which of the following are usually included in a bonds indenture?
The total amount of bonds issued The repayment arrangements
Which of the following are true of bonds?
They are interest only loans They are issued by both corporations and governments They are the major form of corporate debt
Which of the following are features of municipal bonds?
They are issued by state and local governments The interest on municipal bonds is, in some cases, exempt from state taxes in the state of issue The interest on municipal bonds in exempt from federal taxes
T/F: The price you actually pay to purchase a bond will generally exceed the clean price
True
Which are the two unique features of a US federal government bond?
US Treasury issues are considered to be default free US Treasury issues are exempt from state income taxes
What four variables are required to calculate the value of a bond?
Par value Coupon rate Time remaining to maturity Yield to maturity
A corporate bond's yield to maturity
Changes over time Is usually not the same as bonds coupon rate
You invest in a bond paying 6% interest paid semiannually with a fae value of $1,000. The bond matures in 8 years and current market rates are 5%. What is the current value of the bond?
$1,065.28
The degree of interest rate risk depends on _
the sensitivity of the bond's price to interest rate changes
What does historical data suggest about the nature of short-term and long term interest rates?
Sometimes short term rates are higher and sometimes long term rate are higher
The model that correctly specifies the relationship between the nominal rate and the real rate is: R = the nominal rate r = the real rate
(1 + R ) = (1 + r) x (1+h)
The relationship between nominal rate, real rates and inflation is called ___
the Fisher Effect
Bond rating are based on the probability of default risk, which is the risk that __
the bond's issuer may not be able make all the required payments
Bond ratings are based on the probability of default risk which is the risk that
the bonds issuer may not be able to make all the required payments
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
Which of the following variables is NOT required to calculate the value of a bond?
Original issue price of bond
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
What is the definition of a bonds time to maturity?
It is the number of years until the face values are paid off
What is the bid prices?
It is the price at which a dealer is willing to buy securities It is the price an investor will receive if he sells a bond
What is the asked price?
It is the price at which an investor can buy a bond It is the price at which dealer is willing to sell a particular security
Which of the following are true about a bonds face value?
It is the principal amount repaid at maturity It is also known as the par value
Which of the following may increase the yield in corporate bonds as compensation to investors but will not impact Treasury bond yields?
Liquidity premium Default risk premium
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately
Which on of the following is the most important source of risk from owning bonds?
Market interest rate fluctuation
Bonds are classified based on the collateral provided to protect bondholders in case of default. Which of the following are unseccured forms of debt?
Notes Debentures (in the US)
Which of the following terms apply to a bond?
Par value Coupon rate Time to maturity
What are the cash flows involved in the purchase of 5 year zero coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5%?
Pay $800 today and receive $1000 at the end of 5 years
If you are holding two identical bonds except that one matures in 10 years and the other matures in 5 years, which bonds price will be more sensitive to interest rate risk?
The 10 year bond
If you are holding two identical bonds, except that one matures in 10 year and the other matures in 5 years, which bonds price will be more sensitive to interest rate risk?
The 10 year bond
Junk bonds have the following features
They have high probability of default They pay a high rate of interest They are rated below investment grade bonds
The sensitivity of a bonds price to interest rate changes in dependent on which of the following two variables?
Time maturity Coupon rate
The sensitivity of a bonds price to interest rate changes in dependent in which of the following two variables?
Time to maturity Coupon rate
Which three of the following are common shapes for the term structure of interest rates?
Upward sloping Humped Downward sloping
In general, which shape does the term structure of interest rates usually have?
Upward slopping
What is a corporate bond's yield to maturity (YTM)?
YTM is the expected return for an investor who buys the bond today and holds it to maturity YTM is the prevailing market interest rate for bonds with similar features
If a $1,000 face value U.S Treasury bond is quoted at 99.5, then the bond can be purchased
at 99.5 percent of face value plus any accrued interest
A bond with a BBB rating has a ___ than a bond with an A rating.
higher risk of default
A zero coupon bond is a bond that
makes no interest payments
Bonds issued by state and local governments are called __ ___
municipal bonds
ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?
$60 in interest at the end of each year for 10 years and a $1,000 repayment of principal at the end of 10 years
As an investor in the bond market, why should you be concerned about changes in interest rates?
Changes in interest rates cause changes in bond prices
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
What are the three components that influence the Treasury yield curve?
The interest rate risk premium The real rate of return Expected inflation
As a general rule, which of the following are true of debt and equity?
The maximum reward for owning debt is fixed Equity represents an ownership interest
A bonds coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
A limitation of bond rating is that they
focus exclusively on default risk
What are some features of the OTC market for bonds?
OTC dealers are connected electronically The OTC has no designated physical location
What is the inflation premium?
It is the additional return demand by investors to compensate for expected inflation
