Finance Chapter 6 Interest Rates and Bond Valuation
When interest rates in the market rise, we can expect the price of bonds to ____.
decrease
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.
What are municipal bonds?
Bonds issued by state and local governments
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
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.
A corporate bond's yield to maturity:
Changes over time Is usually not the same as bonds coupon rate
What is a bond's current yield?
Current yield = annual coupon payment / price
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?
The 10-year bond
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
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.
What does the clean price for a bond represent?
The quoted price excluding accrued interest
A key difference between interest payments and dividend payments is?
dividends are not tax deductible interest is tax deductible
True or false: Long-term debt has maturities greater than one year.
True
Bond ratings 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
The term structure of interest rates describes ________.
the pure time value of money the relationship between nominal rates and time to maturity
Most of the time, a floating-rate bond's coupon adjusts ____.
with a lag to some base rate
If you are holding a municipal bond that is trading at par to yield 6%, by how much will your after-tax yield change if your federal income tax bracket increases from 15% to 20%. Assume there are no state or local taxes
0%
What is the bid price?
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 to a dealer.
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
Which of the following are true of bonds?
They are issued by both corporations and governments They are normally interest-only loans
The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?
Time to maturity Coupon rate
The US government borrows money by issuing:
Treasury notes and treasury bonds
True or false: A put bond allows the holder to force the issuer to buy the bond back at a stated price.
True
If you are in the 20% federal income tax bracket, what is your 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)
Crossover bonds can also be called _____ bonds.
5B
True or false: Bond ratings are concerned only with the possibility of price changes.
False
What is a bond's accrued interest?
It is interest that has been earned but not yet received by the current bondholder
What does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately.
Which one of the following is the most important source of risk from owning bonds?
Market interest rate fluctuations
What are some features of the OTC market for bonds?
OTC dealers are connected electronically. The OTC has no designated physical location.
Which of the following variables is NOT required to calculate the value of a bond?
Original issue price of bond
What four variables are required to calculate the value of a bond?
Par value Coupon rate Time remaining to maturity Yield to maturity
Which of the following terms apply to a bond?
Par value Coupon rate Time to maturity
What variables are required to calculate the value of a bond?
Remaining life of bond Coupon rate Market yield to maturity
When long-term rates are higher than short-term rates, which of the following shapes will the term structure of interest rates usually have?
Upward sloping
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's coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
Which of the following are bonds that have actually been issued?
a put bond a CoCo bond a convertible bond
The coupon payments on floating-rate bonds are _____.
adjustable
To find the total bond value, add the present value of the amount paid at maturity to the _____ of the annual coupon payments.
annuity present value
If bonds for AT&T are quoted at 115, they can be purchased:
at 115% of par value plus accrued interest
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
The bid-ask spread represents the ___.
dealer's profit
A limitation of bond ratings is that they ____.
focus exclusively on default risk
A bond with a BB rating has a ______ than a bond with an BBB rating.
higher risk of default
Which three of the following are common shapes for the term structure of interest rates?
humped downward sloping upward sloping
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ____.
increases
A zero-coupon bond is a bond that ____.
makes no interest payments
Equity represents a(n) _________ interest of a firm.
ownership
Junk bonds have the following features:
they are rated below investment grade bonds
What does the dirty price represent?
it includes the quoted price and accrued interest
Bonds issued by state and local governments are called _______ ______.
municipal bonds
What are the two major forms of long-term debt?
public issue and private issue
The term structure of interest rates examines the ____.
relationship between short-term and long-term interest rates
What are the three components that influence the Treasury yield curve?
The real rate of return Expected future inflation The interest rate risk premium
Which of the following are usually included in a bond's indenture?
The total amount of bonds issued The repayment arrangements
True or false: Low-grade bonds may not be rated by major rating agencies.
True
True or false: The government sells Treasury notes and bonds to the public every month.
True
True or false: The price you actually pay to purchase a bond will generally exceed the clean price.
True (Invoice price = clean price + accrued interest)
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
A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a _________________.
call provision
A bond's _____ payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
coupon