Finance 350 exam 2
Discount bonds
- YTM > Coupon Rate - selling price is less than face value
Premium bonds
- YTM > coupon rate - selling price is higher than face value
Interest rates and Bond prices
-Inversely related -Bond pays fixed annual interest payment -Lower bond price will raise the interest rate
Which of the following terms apply to a bond a. coupon rate b. time to maturity c. par value d. dividend yield
a. coupon rate b. time to maturity c. par value
Scenario analysis
all variables are examined for a limited range of values (ex: worst and best case scenario)
Coupon rate
annual coupon / par value
current yield equation
annual coupon/price
Price risk
change in price due to changes in interest rates -LT bonds _ Low coupon rates have most of its value in the par value
sinking fund provision
company promises to repurchase the bond through the years.
The bid-ask spread represents the _______.
dealer's profit
Bond
greater than 10 year maturity
Value of a bond
the PV of coupons + par value or PV of an annuity + PV of lump sum
Bond ratings are based on the probability of default risk, which is the risk that _______________.
the bond's issuer may not be able to make all the required payments
Standard deviation
the positive square root of the variance
What is the purpose of a sinking fund?
to create a fund to repay bonds when they fall due.
Reinvestment Risk
uncertainty of rates in the future at which cash flows can be reinvested - ST Bonds _ high coupon rate: harder to find and not certain about future interest rates
note
1-10 year maturity
Medium Grade Bonds
A- through BBB
High grade bonds
AAA-, through AA-
low grade bond
BB through CC
very low grade
C- = not paying interest D- = in default with principal and interest in arrears
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.
The nominal rate is found by adding the ________ and the real rate of return.
Inflation
What is the asked price?
It is the price at which an investor can buy a particular security from a dealer; It is the price at which a dealer is willing to sell a particular security.
What does a treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds.
are dividends tax deductible
NO
A sukuk is a contract that is related to:
Riba, Islamic Law
Variance
The average squared difference between the actual return and the average return; Standard deviation squared
What are the three components that influence the Treasury yield curve?
The interest rate risk premium; the real rate of return; expected future inflation
is interest tax deductible
YES
YTM
Yield to maturity, the required rate of return of a bond.
A sukuk is in compliance with the Islamic law as the financing instrument is not charging any ______________ or making money from money.
interest
Bill
less than one year
Sensitivity Analysis
one variable is examined over a broad range of values (freeze all variables except one)