FIN 357 Chapter 7: Interest Rates and Bond Valuation
Convertible bond
Can be exchanged for shares of stock
True or false: Equity represents an ownership interest.
True
Most of the time, a floating-rate bond's coupon adjusts ____.
with a lag to some base rate
Which one of these correctly specifies the relationship between the nominal rate and the real rate?
(1 + R) = (1 + r) * (1 + h)
A corporate bond's yield to maturity ____.
Can be greater than, equal to, or less than the bond's coupon rate Changes over time
Why does a bond's value fluctuate over time?
The coupon rate and par value are fixed, while market interest rates change
Bond ratings are based on the probability of default risk, which is the risk that ___.
Bond's issuer may not be able to make all the required payments
Which of these are required to calculate the current value of a bond?
Coupon rate Par value Applicable market rate Time remaining to maturity
Which of the following variables are required to calculate the value of a bond?
Coupon rate Remaining life of bond Market yield
What is a real rate of return?
It is a rate of return that has been adjusted for inflation It is a percentage change in buying power
What are some reasons why the bond market is so big?
Many corporations have multiple bond issues outstanding Various state and local governments also participate in the bond market Federal government borrowing activity in the bond market is enormous
What are the two major forms of long-term debt?
Public issue and privately placed
Which of the following are usually included in a bond's indenture?
Repayment arrangements Total amount of bonds issued
What are three important features of Treasury notes and bonds?
Taxable Default-free Highly liquid
Which of the following are usually included in a bond's indenture?
Total amount of bonds issued Repayment arrangements
The main reason it is important to distinguish between debt and equity is that the benefits and risks _____.
are different
Secondary markets in sukuk are extremely illiquid because most sukuk are:
bought and held to maturity
A bond pays annual interest payments of $50, has a par value of $1,000, and a market price of $1,200. How is the coupon rate computed?
coupon / face value = 50 / 1,000
With __________-rate bonds, the coupon payments are adjustable.
floating
The relationship between bond prices and the market rate of interest is ____.
inverse; if the market rate of interest rises, then bond prices will fall
The federal government can raise money from financial markets to finance its deficits by ___.
issuing bonds
The U.S. Treasuries market is the _____ in the world in terms of trading volume.
largest
CAT bond
protects insurance companies from natural disasters
When the term structure of interest rates is downward sloping, ____.
short-term rates are higher than long-term rates
If you own corporate bonds, you will be concerned about interest rate risk as it affects ____.
the market price of the bonds
Most of the time, a floating-rate bond's coupon adjusts ______.
with a lag to some base rate
A bond with exotic features is often called a _____ bond.
cat
A bond pays annual interest payments of $50, has a par value of $1,000, and a market price of $1,200. How is the coupon rate computed?
coupon / face value = 50 / 1000
Within the context of financial markets, complete the following equation: Bid − Ask = ______.
spread
Which of the following are differences between debt and equity?
A corporation's interest payments on debt are tax deductible, but the dividends it pays to equity holders are not Unlike dividend omissions to equity holders, unpaid debt obligations can lead to bankruptcy Equity represents ownership interest while debt does not
Structured note
Based on financial securities, commodities, or currencies
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 is a bond's current yield?
Current yield = annual coupon payment / current price
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
What does the clean price for a bond represent?
The quoted price, which excludes interest accrued since the last coupon date
In financial markets, the difference between the _____ price and the ask price is known as the spread.
bid
The ______ yield is the bond's annual coupon divided by its price.
current
When interest rates in the market rise, we can expect the price of bonds to ____.
decrease
The Fisher effect decomposes the nominal rate into:
inflation rate and real rate
In general, a corporate bond's coupon rate ____,
is fixed until the bond matures
If the term structure of interest rates is upward sloping, then ____.
long-term rates are higher than short-term rates
A zero coupon bond is a bond that ____.
makes no interest payments
If you own corporate bonds, you will be concerned about interest rate risk as it affects ____.
market price of bonds
If a given set of cash flows is expressed in ____________ terms and discounted at the ____________ rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the real rate.
nominal; nominal
The two major forms of long-term debt are _______ issue and privately placed.
public
If a given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ____ rate.
real
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
As a general rule, which of the following are true of debt and equity?
Equity represents an ownership interest Maximum reward for owning debt is fixed
Which of the following is not one of the six factors used to determine the yield on a bond?
Expected future inflation Interest rate risk Default risk Taxability Lack of liquidity Real rate of return Not voting rights
True or false: A bond's value is not affected by changes in the market rate of interest.
False
True or false: The real rate of return will generally be higher than the nominal rate of return.
False; real rate of return < nominal raet
Which of the following institutions issue bonds that are traded in the bond market?
Federal government Public corporations State governments
Which one of the following is the most important source of risk from owning bonds?
Market interest rate fluctuations
Which of the following variables are required to calculate the value of a bond?
Market yield Remaining life of bond Coupon rate
Put bond
Owner can force issuer to repay prior to maturity at a stated price
What are the cash flows involved in the purchase of a 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 percent.
Pay $800 today and receive $1,000 at the end of 5 years
The written agreement between the corporation and the lender detailing the terms of the debt issue is the _______.
indenture
In terms of time to maturity, U.S. Treasury notes and bonds have initial maturities ranging from ___ years.
2 to 30 years
Which is the largest security market in the world in terms of trading volume?
US Treasuries market
The U.S. government borrows money by issuing:
Treasury bonds, bills, and notes
When the U.S. government wants to borrow money for the long-term (more than one year) it issues:
Treasury notes Treasury bonds
The US government borrows money by issuing:
Treasury notes Treasury bonds Treasury bills
True or false: Interest earned on Treasury notes and bonds is taxable
True
True or false: The major difference between Western financial practices and Islamic law is that Islamic law does not permit charging or paying interest.
True
True or false: The price you actually pay to purchase a bond will generally exceed the clean price.
True
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
