FIN640-c7

What is the nominal rate of return on an investment?

It is the rate that has not been adjusted for inflation.

Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?

The asked price The bid price

How is an APR computed?

(Rate per period X Number of periods in a year)

How is investing in US Treasury bonds different from investing in corporate bonds?

- Interest from U.S. treasuries is exempt from taxes at the state level but corporate interest is not - Treasury issues have no default risk

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

All junk bonds typically have which of these features?

-less than investment-grade rating -high probability of default

What is a premium bond?

Bonds with a price greater than par value

Match each one of these bonds with their characteristic.

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

Of the liquidity of a bond increases than the bond's yield will ____.

Decrease

Secondary markets in sukuk are extremely illiquid because most sukuk are:

Secondary markets in sukuk are extremely illiquid because most sukuk are:

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

The total amount of bonds issued The repayment arrangements

If you invest in a corporate bond, how many times can you expect, in general, to receive interest?

Twice a year

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 real rate of return?

it is a rate of return that has been adjusted for inflation

Why is the bond market less transparent than the stock market?

many bond transactions are negotiated privately

The default risk premium refers to the extra compensation demanded by investors for the possibility that the issuer might _____.

not make all the promised payments

How significant is the inflation premium on the shape of the term structure of interest rates?

• Very significant• More significant than the real rate of return

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?

$50/$1000

What are the two unique features of a U.S federal government bond?

-US Treasury issues are considered to be a default-free -US Treasury issues are exempt from state income taxes

Which of the following institutions issue bonds that are traded in the bond market?

-public corporations -state governments -the federal government

When the US government wants to borrow money for 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 are always issued at a discount-zero coupon bonds make no interest payments

At what tax rate will you be indifferent between a muni that yields 7 percent and a comparable corporate bond yielding 9 percent? assume no state taxes.

1-.07/.09= 22.2%

Place the following bonds in order of security as defined in the US.

1. mortgage bonds 2. debentures

What is the current yield on $1,000 par value bond that sells for $900 if the coupon rate is 10 percent?

11.11%. Current yield equals annual amount divided by PV (aka Price of bond). First multiply .10 X $1000 to get payment. It's already annualized at $100.So, $100/$900= .11111=11.11%

A corporation issues 50,000 bonds at $1,000 each. The bonds mature in 5 years and have a coupon rate of 7 percent. What will be the total annual interest expense for the corporation?

3.5 Million

If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bound yielding 5 percent? Ignore state and local taxes.

5%. Interest income from the Muni is exempt from the federal income tax so the after-tax yield equals the before tax yield.

What will your aftertax yield be on a corporate bond that is currently priced to yield 7% percent if you are in the 25 percent tax bracket?

5.25

What is the aftertax yield on a U.S Treasury bond yielding 7 percent if you are in the 20 percent tax bracket?

5.6% .07 X (1- 0.2) = 5.6%

What is the effective annual rate on a bond with a yield maturity of 6 percent that pays semiannual interest?

6.09% [1+(.06/2)]^2-1

The amount by which the call price exceeds the par value of the bond is called:

Call premium

Which of these is included in the calculation of a bond's yield maturity?

Coupon rate, current price, and par value.

Which three of the following are common shapes for the term structure of interest rates?

Downward sloping, upward sloping, and humped.

Which of the following is not a difference between debt and equity?

Equity is publicly traded while debt is not

According to the approximation formula for the nominal rate of return (R), the nominal rate will _______ if inflation (h) increases.

Increase

What are the sources of information for generating bond ratings?

Information from the corporation being rated, and information collected by the bond rating agency.

What is the definition of a bond's time to maturity?

It is the number of years until the face value is paid off

Which of the following are true about a bond's face value?

It is the principal amount repaid at maturity It is also known as the par value

A market is considered transparent if ________.

It's prices and trading volume are easily observed

The reason that interest rate risk is greater for long-term bonds than for short-term bonds is that the change in rates has a greater effect on the present value of ____ value than on the present value of the ____________ payments.

Par, coupon

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

What is the bid price?

The 'bid' price is the highest price at which the dealer is willing to purchase a security.

What does a bond's rating reflect?

The ability of the firm to repay its debt and interest on time

Which of these are required to calculate the current value of a bond?

The coupon rate, applicable market rate (market yield), and the time remaining to maturity (remaining life of a bond).

What does the AAA rating assigned by S&P mean?

The firm is in a strong position to meet its debt obligations

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

The market price of the bonds

What are three important features of Treasury notes and bonds?

They are default free, taxable and highly liquid

Which of the following are features of municipal bonds?

They are issued by state and local governments. The interest on municipal bonds is exempt from federal taxes.

Which of the following terms apply to a bond?

Time to maturity, coupon rate, par value

What information is needed to compute a bond's yield-to-maturity?

Time to maturity, the bond's current price, coupon rate

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

A bond has a quoted price of $984.63, a face value of $1,000, a semi-annual coupon of $20, and a maturity of 10 years. Match its current yield and its YTM below.

YTM= 4.19% Current yield= 4.06%

What are the three components of the nominal rate of return?

compensation for the inflation effect on the investment earnings. compensation for the inflation effect on the original investments real rate of return

Which of the following variables are required to calculate the value of a bond?

coupon rate, market yield, remaining life of bond

When interest rates in the market rise, we can expect the price of bonds to _____.

decrease

Which of the following is true about a multi-year typical bond's coupon?

its a fixed annuity payment

Which six factors determine the yield on a bond?

liquidity, expected future inflation, real rate of return, interest rate risk, default risk, and taxability

What is the present value of the annual interest payments on a 10-year, $1,000 par value bond with a coupon rate of 10 percent paid annually, if the yield on similar bonds is 9 percent?

pv of coupons =C*((1-(1/1+r^t)/r) =641.77

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

What are some reason why the bond market is so big?

state and local gov also participate in bond mktmany co's have multiple bond issues outstandingfederal gov borrowing activity in the bond mkt is enormous

What does a Moody's bond rating of C typical indicate?

the issuer is in default

Which of the following is true about interest rate risk?

the longer the time to maturity, the greater the interest rate risk; the lower the coupon rate, the greater the interest rate risk