Chapter 1 Learnsmart 7, FIN3403-exam2, Fin 3403 Exam 2, Chapter 7, Chapter 7 Finance: Interest Rates and Bond Valuation, FIN 320 CH 6
what does NCAA mean?
"no coupon at all" not good for investors "junk or defaulted" bond
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
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
ABC Co. issued 1 million 6% 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 the 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.
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. What is current yield and YTM.
-Current= 40/984.63= 4.06% -YTM=4.19
What 6 provisions are generally included on the the indenture?
1. the basic term of the bonds 2. the total amount of bonds issued 3. a description of property used as security 4. The repayment arrangements 5. the call provisions 6. details of the protective covenants
What is usually the face value of coporate bonds?
1000
At what tax rate will you be indifferent between a muni that yields 7% and a comparable corporate bond yielding 9%? Assume no state taxes.
22.2%
If you purchase a bond costing 1,143 with a par value of 1,000 that pays a semi-annual coupon of 5%, how much will each coupon payment be?
25
What will your aftertax yield be on a corporate bond that is currently priced to yield 7% if you are in the 25% tax bracket?
5.25%
What is the price of a US Treasury bond listed at 122 if the par value is $5000?
5000 X 122%= $6100
What is a premium bond?
A bond that sells for more than face value
A bond's YTM will exceed its current yield when the bond is selling at ______.
A discount
Structured notes
Based on financial securities, commodities, or currencies
what is default premium risk?
Because bonds are not default free the portion of a nominal interest rate or bond yield that represents compensation for the possibility of default
If a bond has 1. Face Value F 2. a coupon C paid per period 3. t periods to maturity 4. a yield of r per period what is its value?
Bond Value = C* [1-1/(1+r)^t]/r + F/(1+r)^t Present value of the coupons + Present Value of the Face amount
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
Secondary markets in sukuk are extremely illiquid because most sukuk are:
Bought and held to maturity
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
A corporate bond's yield to maturity
Changes over time can be greater than, equal to, or less than the bond's coupon rate
What is a bonds current yield?
Current yield = Annual coupon payment/Current price
What is bonds current yield?
Current yield = annual coupon payment / current price
The bid-ask spread represents the ____.
Dealers profit
A firm's bond rating sheds light on its _________ risk.
Default
How do determine how much a bond should sell for? ex. Butsin issues a bond with $80 coupon, 8 percent interest rate for the next 10 years. In ten years Butsin will pay $1,000 to the owner, what should the bond sell for?
Determine Present Value of the Bond PV = 1000 (1+1.08)^10 = $463.19 find the present value of the annuity Annuity PV = 80 * (1-1/1.08^10)/.08 = $536.81 $436.19 + $536.81 = $1,000 (face value)
What is a discount bond?
Discount bonds are bonds that sell for less than the face value
Cumulative voting means board members are elected one at a time, with each shareholder casting his or her allotted votes for each seat on the board
False
Investing more money in a project is a guarantee of greater profits
False
The MIRR function eliminates multiple IRRs and should replace NPV
False
The discounted payback rule has an objective benchmark to use in decision-making.
False
A PE ratio that is based on estimated future earnings is known as ___ PE ratio.
Forward
Bond J has a coupon rate of 7 percent and Bond K has a coupon rate of 13 percent. Both bonds have 15 years to maturity, make semiannual payments, and have a YTM of 10 percent. If interest rates suddenly rise by 2 percent, what is the percentage price change of these bonds?
In this example, do the same thing as the previous, except the rate for both will be the 10% plus or minus 2, and the coupon rates are only used to determine payment
The most important alternative to the NPV if the __ method
Internal rate of return
The relationship between bond prices and the market of interest is _________
Inverse; if the market rate of interest rises, bond prices fall
Which of the following is a feature of common stock?
It has no special preference in bankruptcy It generally have voting rights It has no special preference in receiving dividends
Which is true about a multi year typical bond's coupon?
It is a fixed annuity payment
Which is the most important source of risk from owning bonds?
Market rate interest rate fluctuations
NASDAQ has which of these features?
Multiple market maker system Computer network of securities dealers
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
Preferred stock preference over common stock in the:
Payments of dividends Distribution of corporate assets
When cash flows are conventional, NPV is
Positive for discount rate below the IRR Negative for discount rates above the IRR Equal to zero when the discount rate equals the IRR
Which is the largest security market in the world in terms of trading volume?
The US Treasuries market
How does time affect interest rate risk?
The longer the time until maturity, the greater the interest rate risk. Interest rate premium increases at a decreasing rate along with the interest rate
If you own corporate bonds, you will be concerned about interest rate risk as it affects ___.
The market price of the bonds.
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
Which of the following is usually a right to common shareholder
The right to purchase a proportional shares of new stock issued Voting rights The right to a proportional share of dividends paid
Which of the following are weaknesses of the payback method?
Time value of money principles are ignored Cash flows received after the payback period are ignored The cutoff date is arbitrary
the US government borrows many by issuing:
Treasury bonds, treasury bills, treasury notes
Two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing
True
what is a cat bond?
a bond issued by reinsurance companies to insure insurance companies
Thus, what might an upward sloping term structure indicate?
anticipated increases in inflation
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
If a $1000 face value US treasury bond is quoted at 99.5, then the bond can be purchased ________.
at 99.5% of face value plus any accrued interest
Why don't US treasury bond have no default risk?
because the treasury can always come up with the moey to make payments
A person who brings buyers and sellers together is called a(n) _____.
broker
The amount by which the call price exceeds the par value of the bond is called
call premium
The largest number of NYSE members are registered as ___.
commission brokers
Suppose Bob owns 20 shares and Vikki owns 30 shares in Good Company, and there are five members of the board of directors. Under which voting arrangement can Bob assure himself of a board member that represents his interest?
cumulative voting
What are treasury notes three most important features?
default free Taxable highly liquid
An __ project does not rely on the acceptance or rejection of another project
independent
An ______ project does not rely on the acceptance or rejection of another project
independent
The most important alternatives to NPV is the ___ method.
internal rate of return
The point at which the NPV profile crosses the horizontal axis is the:
internal rate of return
Stock price reporting has increasingly moved from traditional print media to the __ in recent years
internet
Stock price reporting has increasingly moved from traditional print media to the ___ in recent years.
internet
What is the nominal rate of return on an investment?
it is the actual percentage change in the dollar value of an investment
What is the definition of a bond's time to maturity?
it is the number of years until the face value is due to be repaid
What is the definition of a bonds time to maturity?
it is the number of years until the face value is due to be repaid
What is the nominal rate of return on an investment?
it is the rate that has not been adjusted for inflation
What will happen to the default risk premium during periods of economic uncertainty?
it will increase
What is an interest-only loan?
it's a loan which the borrower pays interest periodically and repays the principle when the bond matures
A market is considered transparent if ____.
its prices and trading volume are easily observed
A zero coupon bond is a bond that
makes no interest payments
A zero- coupon is a bond that
makes no interest payments
A zero-coupon bond is a bond that ___
makes no interest payments
Why is the bond market less transparent than the stock market?
many bond transactions are negotiated privately
Why is the bond market less transparent than the stock market?
many bonds transactions are negotiated privately
When cash flows are conventional, NPV is ___ if the discount rate is above the IRR
negative
Which of the following occurs in the primary market>
newly-issued stocks are initially sold
What are debt securities typically called?
notes, bonds, debentures,
what must we know in order to determine the value of a bond at a particular time?
t (time) Face value the coupon and the market interest rate for bonds with similar features
what is the asked price?
the price the dealer is willing to take for the security
What is the face value/par value of a bond?
the principal amount of a bond that is repaid at the end of the term. Also called par value
what three components doe the yield curve represent?
the real rate expected future inflation the interest rate risk premium
what are TIPS?
treasury inflation protected securities.
Who usually represents the bondholders?
usually a trustee appointed by corporation
What are municipal bonds?
bonds that have been issued by state or local governments
Secondary markets in sukuk are extremely illiquid bc most sukuk are:
bought and held to maturity
Secondary markets in sukuk are extremely illiquid because most sukuk are:
brought and held to maturity
Capital ___ is decision-making process for accepting and rejecting projects
budgeting
Capital ___ is the decision-making process for accepting and rejecting projects
budgeting
Why is the bond market so big?
-Fed gov borrowing activity in the bond market is enormous -Many corps have multiple bond issues outstanding -Various state and local govts also participate in the bond market
What are some features of the OTC market for bonds?
-OTC dealers are connected electronically -OTC has no designated physical location
What are some features of the OTC market of bonds?
-OTC dealers are connected electronically -The OTC has no designated physical location
Which institutions issue bonds that are traded in the bond market?
-Public corps -Federal gov -State gov
Which variables are required to calculate the value of a bond?
-Remaining life of bond -Market yield -Coupon rate
Which are usually included in a bond's indenture?
-Repayment arrangements -Total amount of bonds issued
Which are common protective covenants?
-The firm must maintain working capital at or above a specified level -The firm must limit dividends to equity holders -The firm cannot merge with any other firm
What are the two unique features of a US federal government bond?
-US treasury issues are exempt from state income taxes -US treasury issues are considered to be default free
What is a corporate bond's yield to maturity?
-YTM is the prevailing market interest rate for bonds with similar features -YTM is the expected return for an investor who buys the bond today and holds it to maturity
Which of the following are features of common stock?
-it has no special preference in bankruptcy -it generally has voting rights -it has no special preference in receiving dividends
Which of the following are true about a bond's face value?
-it is also known as the par value -it is the principal amt repaid at maturity
When cash flows are conventional, NPV is ____.
-negative for discount rates above the IRR -positive for discount rates below the IRR -equal to zero when the discount rate equals the IRR
Three special case patterns of dividend growth include:
-non-constant growth -zero growth -constant growth
How significant is the real rate of return in determining the shape of the term structure of interest rates?
-not very significant -less significant than inflation
How is investing in US Treasury bonds different from investing in corporate bonds?
-treasury bonds have no default risk -interest from US Treasuries is exempt from taxes at the state level but corporate interest is not
What are some reasons why the bond market is so big?
-various state and local governments also participate in the bond market -many corporations have multiple bond issues outstanding -federal government borrowing activity in the bond market is enormous
CORPORATE BONDS ARE USUALLY CALLABLE
...
DETERMINANT OF BOND YEILDS
...
Three common types of sinking fund?
1. some sinking funds start about 10 years after the initial issuance 2. some sinking funds establish equal payments over the life of the bond 3. high-quality bond issues establish payments to the sinking fund that are not sufficient to redeem the entire issue. As a consequence, there is a large balloon payment at maturity.
The three attributes of NPV are that it:
1. uses all the cash flows of a project 2. uses cash flows 3. discounts the cash flows properly
The nominal rate is 15.5% and the inflation rate is 5%, what is the real rate.
1.155 =(1 +r)*(1.05) 1.1 = 1+r r= 0.1 or 10%
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 the total annual interest expense be for the corporation?
3.5 million (???)
Use your Calculator to find the YTM on a 20 year, $1000 par value bond that pays coupons of 4.5% semi-annually and currently sells for $1104.89.
3.75%
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
If you are in the 20 percent tax bracket, what is your after-tax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes.
5% ( interest income from a muni is exempt from federal income tax so the after-tax yield equals the before tax yield)
Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose a German company issues a bond with a par value of €1,000, 20 years to maturity, and a coupon rate of 6.2 percent paid annually. If the yield to maturity is 7.3 percent, what is the current price of the bond?
=62*((1-(1/(1.073)^20/.073))+(1000/(1.073)^20) =886.13
Sqeekers Co. issued 10-year bonds a year ago at a coupon rate of 7 percent. The bonds make semiannual payments and have a par value of $1,000. If the YTM on these bonds is 5.3 percent, what is the current bond price?
=PV(0.0265,18,35,1000,0) =1120.44
A bond pays annual interest payments of $50, pas a par value of $1000, and a market price of $1200. How is the coupon rate computed?
=annual coupon/ face value =50/1000
Which on of the following is the most important source of risk from owning bonds?
Market interest rate fluctuation
What is the highest rating a frim can have?
AAA or Aaa and such debt is judged to be the best quality and to have the lowest degree of risk factor
Payback period tells the time it takes to break even in an ___ sense. Discounted payback tells the time it takes to break even in an __ or financial sense.
Accounting Economic
When an investor sells a bond to a dealer, the price paid by the dealer is known as the ____.
Bid price
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)
When interest rates in the market rise, we can expect the price of bonds to __
Decrease
The formula for valuing a constant growth stock is:
P0=D1/(R-g)
The PI rule for an independent project is to __ the project if the PI is greater than 1.
accept
The PI rule for an independent project is to ___ the project if the PI is greater than 1.
accept
The present value of all cash flows (after the initial investment) is divided by the ____ to calculate the profitability index.
initial investment
The present value of all cash flows after initial investment is divided by the __ to calculate the profitability index
initial investment
The present value of all cash flows after the initial investment is divided by the ___ to calculate the profitability index
initial investment
A bond yield to maturity considers the interest earnings and the change in the bonds price while the current yield considers __.
interest earnings only
Fundamentally, the business of the NYSE is to attract and process __.
order flow
A bond's yield to maturity considers the total interest earnings and the change in the bond's price while the current yield considers ____.
the annual coupon payment and the bond price
Which quote, asked or bid, would an investor be expected to pay to a dealer if he or she was buying a bond from the dealer?
the asked price
Which quote, asked or bid, would you expect to pay if you were buying a bond?
the asked price
What is the bid price
the bid is the price at which a dealer is willing to buy securities
Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?
the bid price the asked price
Which of the following are common protective covenants
the firm must maintain working capital at or above a specified level the firm must limit dividends to equity holders the firm cannot merge with any other firm
what is bearer form?
the form of bind issue in which the bind is issued without record of the owners name. payment is made to whomever sends in the coupons attached to the bonds
What is registered form?
the form of bond issued in which the registrar of the company records ownership of each bond payments made directly to the owner
what does it mean to say that The difference in interest rate risk increases at a decreasing rate?
the graph has a steep upward slop (bxt year 1 and 10) and then begins to level off around year 20-30
Which of the following are features of municipal bonds?
the interest on municipal bonds is exempt from federal taxes they are issued by state and local government
Who is the creditor/lender?
the person loaning the money
If the rate of inflation is 3 percent and the real rate of return is 5 percent, the nominal rate is approximately __ percent
8 percent
What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?
9.70%
What is the PI for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12 percent?
=((80/1.12)+(20/1.12^2))/30=2.91
What is a real rate of return?
It is a rate of return that has been adjusted for inflation
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
For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed
false
For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.
false
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 these bonds?
60 in interest at the end of each for 10 years and a 1,000 repayment of principle at the end of 10 years.
What will happen to a bonds time to maturity as the years go by?
It will decline
What will happen to the default risk premium during periods of economic uncertainty?
It will increase
A market is considered transparent if
Its prices and trading volume at easily observed
A zero-coupon bond is a bond that ___.
Makes no interest payments
The crossover rate is the rate at which the NPVs of two projects are equal
True
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6 percent?
$5.94 NPV= -95+(107/1.06) = $5.94
A bond pays annual interest payments of $50, has a par value of $1000, and a market price of $1200. How is the coupon rate computed?
$50/$1,000
How is a zero coupon bond different from a conventional bond?
-ZC make no interest payments -ZC bonds have always been issued at a discount
A benchmark PE ratio can be determined using:
-a company own historical PEs -the PEs of similar companies
As a general rule, which of the following are true of debt and equity?
-equity represents an ownership interest -the max reward for owning debt is fixed
All junk bonds typically have which of these features?
-high probability of default -less than investment-grading rating
What are three important features of Treasury notes and bonds?
-highly liquid -taxable -default free
Which three of the following are common shapes for the term structure of interest rates?
-humped -downward sloping -upward sloping
Which three components determine the shape of the term structure of interest rates?
-inflation premium -real interest rate -interest rate risk premium
Arrange the steps involved in the discounted payback period in order starting with the first step.
1. discount the cash flows using the discount rate 2. add the discounted cash flows 3. accept if the discounted payback period is less than pre-specified number of years.
What are securities issued by corps classified as?
1. equity securities 2.debt securitities
Bond Yields represent the combined effect of no fewer than six things, what are these six things?
1. expected future inflation 2. interest rate risk 3. default risk 4. taxability 5. lack of liquidity
What are the weaknesses of the discounted payback period?
1. loss of simplicity as compared to the payback method 2. exclusion of some cash flows 3. arbitrary cutoff date
The reason that interest rate risk is greater for ___ term bonds than for ___ term bonds is that the change in rates has a greater effect on the present value of the ___ than on the present value of the ___.
Long Short Face value coupon payments
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately
To determine the real rate. How many pizzas at $5 per pizza can we buy with 115.50? After inflation (5% per year) pizza increase to $5.25, now how many pizzas can we buy?
The investment is $100 intiaially. Before i take the invesment i could buy 100/5 = 20 pizzas after investment (one year later at 5% inflation rate) i could buy 115.50/5.25 = 22 pizzas rate of return 20/22 = .909 or 9.09 percent richer
Which of the following are reasons why it is more difficult to value common stock than it is to value bonds?
The life of a common stock is essentially forever The rate of return required by the market is not easily observed Common stock cash flows are not known in advance
what is the yield to maturity?
The rate requires in the market on the bond It is the interest rate by which the present values of all the future cash flows are equal to the bond's price.
What determines the shape of the term structure of interest rates?
The real rate of interest the rate of inflation The interest rate premium
Which of the following variables are required to calculate the value of a bond?
coupon rate, market yield, remaining life of bond
Which of these included in the calculation of a bond's yield to maturity?
current price, coupon rate, par value
what is a bond's current yield?
current yield= annual coupon/ current price
Bourdon Software has 9 percent coupon bonds on the market with 20 years to maturity. The bonds make semiannual payments and currently sell for 107.3 percent of par. What is the current yield on the bonds?
current yield= annual coupon/ current price =90/1073
Someone who maintains an inventory of stocks and buys and sells those stocks is known as a ___.
dealer
If the liquidity of a bond increases then the bond's yield will
decrease
If the liquidity of a bond increases then the bond's yield will _____.
decrease
All else constant, the dividend yield will increase if the stock price ____
decreases
The constant-growth model infers that
dividends change at a constant rate
When interest rates in the market fall, bond values are likely to increase because the present value of the bond's remaining cash flows ____.
increases
When is the term structure of interest rates a "hump"
interest rates increas at first but then begin to decline as we look at longer and longer tern rates,
Which of the following occurs in the primary market?
newly-issued stocks at initially sold
What is a blanket mortgage?
pledges all the real property owned by the company
who is the borrower?
the person borrowing the money, making interest payments, and repaying the money
What is the inflation premium?
the portion of a nominal interest rate that represents compensation for expected future inflation
What is a taxability premium?
the portion of nominal interest rate or bond yeild that represents compensation for unfavorable tax status
What is a liquidity premium?
the portion or nominal interest rate or bond yield that represents compensation for lack of liquidity less liquid bonds have higher yields than more liquid bonds
When valuing a stock, the advantage to considering the stock price in the distant future (rather than a more near-term price) as a cash flow is that:
when discounted to present value, a stock price in the distant future is nearly zero
A zero growth model for stock valuation is distinguished by a ___
constant dividend amount
The __ can be interpreted as the capital gains yield
constant growth rate
The ___ can be interpreted as the capital gains yield.
constant growth rate
How is a conventional bond different from a zero coupon bond?
conventional bonds can sell at par, at a discount from par, or at a premium over par value while zeroes can not A conventional bond pays periodic whiles zeroes make no interest payments
what are income bonds?
coupon payments depend on company income only paid if company has sufficient income
All esle constant, the dividend yield will increase if the stock price ___.
decreases
What are the three important features of treasury notes and bonds?
default-free, highly liquid, taxable
What is a discount bond?
discount bonds are bonds that sell for less than face value
NPV __ cash flows properly
discounted
The constant-growth model infers that ____.
dividends change at a constant rate
Which one of the following is true about dividend growth patterns?
dividends may grow at a constant rate
Which of the following represents the valuation of stock using a zero-growth model?
dividends/discount rate
which three of the following are common shapes for the term structure of interest rates?
downward sloping, upward sloping, humped
Why are the yields of municipal bonds much lower than the yields of taxable bonds?
due to the large tax benefit
what is NOT a difference between debt and equity?
equity is publicly traded while debt is not
what dies the value of the floating bond depend on?
exactly how the coupon payments adjustments are defined
The price of a share of common stock is equal to the present value of all ___ future dividends.
expected
The price of common stock is equal to the present value of all __ future dividends
expected
Cumulative voting means board members are elected one at a time, with each shareholder casting his or her allotted votes for each seat on the board.
false
Investing more money in a project is a guarantee of greater profits.
false
The MIRR function eliminates multiple IRRs and should replace NPV
false
The discounted payback rule has an objective benchmark to use in decision-making.
false
A limitation of bond rating is that they
focus exclusively on default risk
one requirement of the dividend growth model is:
for the dividend growth model to be useful, the long term rate must be smaller than the discount rate
A PE ratio that is based on estimated future earnings is known as a ____ PE ratio.
forward
An asset's value is determined by the present value of its ____ cash flows.
future
The profitability index is calculated by dividing the PV of the ____ cash flows by the initial investments
future
The profitability index is calculated by dividing the PV of the ___cash flows by the initial investment
future
One requirement of the dividend growth model is:
g<R
what is collateral?
general term that frequently means securities that are pledged as security for repayment of debt. any asset pledge on debt
In an inflationary environment, the nominal rate will be ___ the real rate.
greater than
The value of a firm is the function of its ___ rate and its ___ rate.
growth; discount
The value of the firm is the function of its __ rate and its __ rate
growth; discount
what is the inflation linked bond?
have coupons that are adjusted according to the rate of inflation. (principal amount maybe adjusted as well).
A bond with a BBB rating has a ___ than a bond with an A rating.
higher risk of default
A bond with a BBB rating has a ____ than a bond with an A rating.
higher risk of default
waht is note used for?
if the maturity for unsecured bond is 10years or less
A humped term structure of interest rates indicates that interest rates are expected to _____ as the time to maturity increases.
increase and then decline
What is seniority in debt?
indicates preferences in position over other lenders, (can be label senior or junior) subortinants paid off only after junior and seniors debt always paid before equity
what might a downward sloping term structure indicate?
inflation will be falling in the future
What is the value of a bond based largely on?
interest rates
What are nominal rates?
interest rates of return that have not been adjusted for inflation the percentage change in the number of dollars you have
What are real rates?
interest rates that have been adjusted for inflation is the percentage change in how much you can buy with your dollars. the % change in your buying power
The relationship between bond prices and the market rate of interest is
inverse, if the market rate of interest rises, bond prices will fall
In general, a corporate bond's coupon rate _____.
is fixed until the bond matures
A bond's credit ratings can change if...
issuers financial standing improves or deteriorates
IRR continues to be popular in practice, partly because:
it gives a rate of return rather than a dollar value
IRR continues to be very popular in practice, partly because:
it gives a rate of return rather than a dollar value
Which of the following is true about a multi-year typical bond's coupon?
it is a fixed annuity payment
What is a real rate of return?
it is a rate of return that has been adjusted for inflation
Which of the following are true about a bond's face value?
it is also known as the par value it is the principle amount repaid at maturity
One common reason for having two classes of common stock with different voting rights is:
it is easier for insiders such as founding families to maintain control of the company
Which of the following are advantages of AAR?
it is easy to compute needed information is always available
If a $1000 par value bond is trading at a discount, it means that the market value of the bond is ____ $1000
less than
What six factors determines the yield on a bond?
liquidity, expected future inflation, real rate of return, interest rate risk, default risk, and taxability
The reason that interest rate is greater for __ term bonds than for__ term bonds is that the change in rates has a greater effect on the present value of the ___ than on the present value of the __.
long; short; face value; coupon payments
The reason that interest rate risk is greater for ____ term bonds than for ____ term bonds is that the change in rates has a greater effect on the present value of the ___ than on the present value of the ____.
long; short; face value; coupon payments
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 short term debt securities?
maturity occurs in one year or less. unfunded debt
Place the following bonds in order of security as defined in the US.
mortgage bonds Debentures
Most voting in large corporations is done by proxy bc:
most small shareholders do not attend the annual meeting
Bonds issued by state and local governments are called __ ___
municipal bonds
The payback period rule __ a project it if has a payback period that is less than or equal to a particular cutoff date.
suggests accepting
The payback period rule ___ a project if it has a payback period that is less than or equal to a particular cutoff date.
suggests accepting
The point at which the NPV profile crosses the vertical axis is the:
sum of the cash flows of the project
The point at which the NPV profile crosses the vertical axis is the:
sums of the cash flows of the project
What else is unique (taxwise) about treasury bonds?
taxed only at the federal level on the coupons recieved. Not taxed at state level
What are treasury prices qouted in?
the 32nds so 137.29 actual means 137 29/32 so 137.90625
The relationship between nominal rate, real rates and inflation is called ___
the Fisher Effect
What is the the N and PMT for a bond with face vaule of 1000 that is 6 percent paid semiannually?
the PMT = 1000*6% = 60/2 = $30 the N is years to maturity * 2 so 10*2 = 20
What is the coupon rate of a bond?
the annual coupon divided by the face value of a bond interest payment/face value
Which of the following entities declares a dividend
the board of directors
Which of the following entities declares a dividend?
the board of directors
What is a call protected bond?
the bond in the stage of deferred cell provision
what occurs to bond when interest rates decline?
the bond is worth more
What does it mean to say that the bond with the lower coupon has a higher interest rate risk?
the bond with the higher coupon has larger cash flow early in life, so its value is less dependent on the face value amount and fluctuation in interest rate.
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
The amount by which the call price exceeds the par value of the bond is called:
the call premium
Is the call price above or below face/par value?
the call price is generally above
What occurs to the cash flow of bond when interest rates fluctuate in the market?
the cash flows from bonds stay the same.
what is the second to last and the last quoted item in TRACE?
the change in asked price from the previous day (in 32nd ticks) the yield to maturity
What is the interest rate risk premium?
the compensation investors demand for bearing interest rate risk Increases with the length of maturity
What is the real rate of interest?
the compensation investors demand for forgoing the use of their money think of it as the pure time value of money after adjusting for inflation basic component underlying every interest rate, regardless of matutity
What is the second main difference bxt debt and equity?
the corporations payment of interest on debt is considered a cost doing business and is fully tax deductible. Dividends paid to stockholders are NOT tax deductible.
what are floating rate bonds?
the coupon payments are adjustable. the adjustments are tied to an interest rate index
Why does a bond's value fluctuate over time?
the coupon rate and par value are fixed, while market interest rates change
what is the bid-ask spread?
the difference between the bid price and the asked price represents dealers proft
what is call premium
the difference bxt the call price and the stated value the amount of call premium may become smaller over time
When the stock being valued does not pay dividends,
the dividend growth model can still be used
issuing bonds
the federal government can raise money from financial markets to finance its deficits by?
What does the AAA rating assigned by S&P mean?
the firm is in a strong position to meet its debt obligations
two common features of floaters?
the holder has the right to redeem the note at par on the coupon payment date after some specified amount of time. this is call a put provision 2. the coupon rate has a floor and a ceiling (max or min),
What does a moody's bond rating of C typically indicate?
the issuer is in default
Taxes of the zero coupon bond?
the issuer must deduct interest every year even though no interest is paid. the owner must pay taxes on interest every year even though no interest is actually recieved
what is the maturity of the long-term debt instrument?
the length of time debt is outstanding with unpaid balance
What occurs if investors believe the rate of inflation will be higher in the future?
the long-term nominal interest rates will tend to be higher than the short term rates
If you own corporate bonds, you will be concerned about interest rate risk as it affects ___.
the market price of the bonds
What strongly influences the rate of the term structure?
the potential for future inflation
What occurs to bond when interest rates rise?
the present value of a bond's remaining cash flow declines bond is worthless
What is the dirty price?
the price of the bond including accrued interest also known as the full or invoice price the price the buyer actually pays
What is the clean price?
the price of the bond net the accrued interest. this is the price that is typically quoted
what is the bid price?
the price the dealer is willing to pay for the security
How is the real rate of return different from the nominal rate of return?
the real rate of return excludes inflation from the nominal rate
What are the three components of the nominal rate?
the real rate on the investment compensation for the decrease in the value of money originally invest because of inflation h compensations for the fact that the dollars earned on the investment are also worth less because of inflation (usually dropped because pretty small)
What is the term structure of interest rates? pure time value of money.
the relationship between the nominal interest rates on the default free, pure discount securities and time to maturity. That is the pure time value of money. involve no risk of default and a single lump sum for future payment.
Which if the following are usually included in a bond's indenture?
the repayment arrangements the total amount of bonds issued
The degree of interest rate risk depends on _
the sensitivity of the bond's price to interest rate changes
what is the maturity?
the specified date on which the principal amount of a bond will be paid. usually 30 years for a corporation
What is the coupon of a bond?
the stated interest payment made on the bond.
what is the break even tax rate?
the tax rate at which an investor would be indifferent between a taxable and a nontaxable issue
What does the shape of the yield curve represent?
the term strucWture of interest rates
Suppose I want to withdraw money each year fort he next three years and I want each withdraw to have $25,000 worth of purchasing power as measured in current dollars. If the inflation rate is 4% what must occur to the withdrawals each year?
the withdrawals must increase by 4% each year. C1 =25,000 * 1.04 = 26,000 C2 = 25,000 * (1.04)^2 = 27,040 C3 = 25,000 * (1.04)^3 = 28,121.60 ect...
what is an indenture?
the written agreement between the corporation (borrower) and its creditors deed of trust
drawbacks to bearer form?
they are difficult to recover if they are lost or stolen because the company does not know who owns the bonds, it cannot notify the bondholders of important events
How do government or corporation borrow money long term?
they issue bonds
What is the straight-line basis for calculating interest expense?
total amount of interst "paid over the year" / the number of years
If a $1000 par value bond is trading at a premium, the bond is
trading for more than $1000 in the market
The US government borrows money by issuing
treasury bills treasury notes treasury bonds
The US government borrows money by issuing:
treasury bonds, treasury bills, treasury notes
IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects.
true
In general, the price that is paid for a bond will exceed its quoted price.
true
It can be advantageous to have a staggered board bc it provides "institutional memory"
true
Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.
true
The crossover rate is the rate at which the NPV's of 2 projects are equal.
true
If you invest in a corporate bond, how many times can you expect, in general, to receive interest?
twice a year
What is the third main difference bxt debt and equity?
unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. This action can result in liquidation or reorganization. or bankruptcy financial failure is not a possibility when equity is issued
what is the most common shape of the term structure?
upwards sloping
Why do corporations try to create a debt security that is really and equity?
want to obtain tax benefits of debt while avoiding bankruptcy
How do we determine the made whole price?
we calculate the present value of the remaining interest and principal payments at a rate specificed in the indenture
What is a discount bond?
when a bond sells for less then its face value
what is a premium bond?
when a bond sells for more then face value
what is a "make-whole" call
when the bond is called the lender get the what the bond is worth. don't lose money and are "made whole"
When is the term structure of interest rates upward sloping?
when the longterm rates are higher than the short term rates
When is the term structure of interest rates downward sloping?
when the short term rates are higher than the long term
in most case how are coupons adjusted?
with a lag to a base rate
What is the current yield on 1,000 par value bond that sells for 900 if the coupon rate is 10%
(.10*1,000)/900 = 11.11
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)
What is the present value of these cash flows in the appropriate real discount rate?
(1.1) = (1+r) *(1.04) 1.0577 = 1+r r = 5.77% PV = 25,000 [1-(1/1.0577^3)]/0.0577 = $67,110.68
How is a conventional bond different from a zero coupon bond?
*Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeros can not. *A conventional bond pays periodic interest whiles zeros make no interest payments.
Which of the following terms apply to a bond?
*Par value *Coupon rate *Time to maturity
Which of the following are common protective covenants?
*The firm must limit dividends to equity holders *The firm must maintain working capital at or above a specified level *The firm cannot merge with any other firm
When the U.S. government wants to borrow money for the long-term (more than one year) it issues:
*Treasury Bonds *Treasury Notes
How is the zero coupon bond different from a conventional bond?
*Zero coupon bonds make no interest payments *Zero coupon bonds are always issued at a discount
If a project has multiple internal rates of return, which of the following methods should be used?
-MIRR -NPV
The NYSE differs from the NASDAQ primarily bc the NYSE has:
-an auction market -a physical location -specialist
A corporate bond's yield to maturity ____.
-changes over time -can be greater than, equal to, or less than the bond's coupon rate
NASDAQ has which of these features?
-computer network of securities dealers -multiple market system
What is included in the calculation of a bond's yield to maturity?
-coupon rate -current price -par value
Which term applies to a bond?
-coupon rate -par value -time to maturity
Which of the following terms apply to a bond?
-coupon rate -time to maturity -par value
Which of these is included in the calculation of a bond's yield to maturity?
-current price -coupon rate -par value
What information do we need to determine the value of stock using the zero-growth model?
-discount rate -annual dividend amt
Preferred stock has preference over common stock in the:
-distribution of corporate assets -payment of dividends
Which of the following are expected cash flows to investors in stocks?
-dividends -capital gains
Which of the following are advantage(s) of AAR?
-easy to compute -needed info is always available
According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada?
-net present value -internal rate of return
In which way(s) is preferred stock like a bond?
-preferred stock sometimes has a sinking fund, giving it a set maturity like bonds -some preferred stock has credit ratings, like bonds -preferred shareholders receive a stated value if the firm liquidates, like bondholder -preferred shareholders receive a stated dividend, similar to interest on a bond
Which six factors determine the yield on a bond?
-real rate of return -interest rate risk -expected future inflation -liquidity -default risk -taxability
Which of the following variables are required to calculated the value of a bond?
-remaining life of bond -coupon rate -market yield
Which of the following projects is acceptable if the average accounting return is required to be at least 20%?
-restaurant: average income = $450,000, Average book value= $2,180,000 -book store: average income= $140,000, Average book value= $600,000
Which of the following institutions issue bonds that are traded in the bond market?
-state governments -public corporations -federal government
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
Which of the following are features of municipal bonds?
-the interest on municipal bonds is exempt from federal taxes -they are issued by the state and local governments
Which of the following are reasons why it is more difficult to value common stock than it is to value bonds?
-the life of a common stock is essentially forever -the rate of return required by the market is not easily observed -common stock cash flows are not known in advance
Which of the following is usually a right of common shareholders?
-the right to a proportional share of dividends paid -voting rights
Which of the following are usually included in a bond's indenture?
-the total amount of bonds issued -the repayment arrangements
Saxon Company is considering a project that will generate NI of $50,000 in Year 1, $75,000 in Year 2, and $90,000 in Year 3. The cost of the project is $700,000, and this cost will be depreciated to $0 in the 3 years of the investment. What is their AAR?
20.48%
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
22.2%
Use your calculator to find the YTM on a 20 year, $1000 par value bond that pays coupons of 4.5% semi-annually and currently sells for $1104.89
3.75%
If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes
5%
A firm decides to raise money by issuing 5 million bonds with a par value of 5,000 each for 10 years at a coupon rate of 7 percent. At the time of the issue, the bonds were sold for 5,500 each. What will the par value of the bonds be in year 5?
5,000 per bond
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 is the price of a US treasury bond listed at 122 if the par value is $5000?
6100
if an investment appreciates by 7 percent while the rate of inflation is 2 percent, what is the nominal rate of return?
7 percent
If an investment appreciates by 7 percent while the rate of inflation is 2%, what is the nominal rate of return?
7%
What is the value of stock if next year's dividend is 6, the discount is 11 and the constant rate of growth is 3 percent?
75 = 6/(.11-.03)
What is the effective annual rate for a bond with a 7% yield to maturity that makes semi annual interest payments? (hint: 7% annual is 3.5% per 6 month period)
=(1.035)^2-1 =7.12%
A Japanese company has a bond outstanding that sells for 90 percent of its ¥100,000 par value. The bond has a coupon rate of 4.9 percent paid annually and matures in 20 years. What is the yield to maturity of this bond?
=RATE(20,49,-900,1000,0,0) =5.75%
What is a bond's current yield?
=annual coupon payment/ current price
What are zero coupon bonds?
A bond that makes no coupon payments and is thus initially priced at a deep discount. although no interest is paid, zero coupon bonds calculations use semiannual periods to be consistent with coupon calculations
A bond's YTM will exceed its yield when the bond is selling at ___.
A discount
Suppose that today you buy a bond with an annual coupon of 7 percent for $1,090. The bond has 14 years to maturity. A) What rate of return do you expect to earn on your investment? Assume a par value of $1,000. B) What is the HPY on your investment? (your realized return is known as the holding period yield)
A) =RATE(14,70,-1090,1000,0,0) B)
what is the current yield of a bond?
Bonds annual coupon/ price of bond Higher then yield for maturity on premium bonds because ignored the loss lower then yield for maturity on discount bonds because ignored the gain
What are municipal bonds?
Bonds that have been issued by state or local governments
Match each one of these bonds with their characteristics
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
Matthews Company has two classes of common stock, and each share represents the same proportion of ownership in the company. Class A has 2 votes for each share. Class B has one vote per share. Which class is more valuable?
Class A
How has TRACE improved transparency in the corporate bond market?
Corporate bond dealers are now required to report trade info through TRACE
What is the first main difference bxt debt and equity?
Debt is NOT ownership interest in firms. Creditors don't have voting power
The three attributes of NPV are that it:
Discounts the cash flows properly Uses all the cash flows of a project Uses cash flows
In the dividend discount model, the expected return for investors from which two sources?
Dividend yield Growth rate
How do we determine effect of inflation on the present value?
Either discount nominal cash flows at a nominal rate or discount real cash flows at a real rate?
The benefits and downfalls of equity
Equity = ownership interest. potential for greater reward. paid after creditors. tax payment on dividends
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
The discounted payback period has which of the following weaknesses?
Exclusion of some cash flows Arbitrary cutoff date Loss of simplicity as compared to the payback method
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 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
What is a bonds accrued interest
It is interest that has been earned but not yet received by the current bondholder
What is the inflation premium?
It is the additional return demand by investors to compensate for expected inflation
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 bond's face value?
It is the principal amount prepaid at maturity
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
What does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
All junk bonds typically have which of these features?
Less than investment-grade rating. High probability of default
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
All else held constant, the yield on a highly liquid bond will be __ the yield on a illiquid bond
Lower than
Suppos taxable bonds are currently yielding 8% whilea te the same time munis of comparable risk and maturity are yielding 6%. Which is more attractive to an investor in the 40 % tax brackets.
Munis: 8 * (1-.40) = 4.8 percent prefers the municipal bond
If a project has multiple internal rates of return, which of the following methods should be used
NPV MIRR
What is the NPV of a project with an initial investment of 95, a cash flow in one year of 107 and a discount rate of 6 percent?
NPV= -95+(107/1.06)= 5.94
WinWin corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?
No shareholder would have enough votes to win any seat on the board, so minority shareholders interests would not be necessarily be protected
Is a company required to pay preferred dividends?
No; the company may defer dividends on preferred stock; however they can not pay dividends to common shareholders until preferred dividends are paid
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
In which ways is preferred stock like a bond?
Preferred shareholders receive a stated value if the firm liquidates, like bondholders Some preferred stock has credit ratings, like bonds Preferred shareholders receive a stated dividend, similar to interest on a bond Preferred stock sometimes has a sinking fund, giving it a set maturity like bonds
The IRR rule can lead to bad decisions when ____ or ____.
Projects are mutually exclusive, cash flows are not conventional.
A part of the indenture limiting certain actions during the term of the loan are termed ____
Protective covenants
what is a put bond?
Put bond gives the owner of bond the right to force the issuer to buy back the security (usually at face value) prior to the maturity date
What is the equation of the nominal rate of return?
R= r + h
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 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
How did the trade report compliance engine make the bond market more transparent?
TRACE shows the trade information for corp bonds
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
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
What is the asked price?
The asked price is the price at which a dealer is willing to sell
Which two prices can be found in the Wall street journal daily treasury bond listing?
The asked priced The bid price
The amount by which the call price exceeds the par value of the bond is called:
The call premium
What is the difference between a bonds "clean price" and its "dirty price"?
The clean price excludes interest accrued since the last coupon payment, while the dirty price includes accrued interest.
Why does a bond's face value fluctuate over time?
The coupon rate and par value are fixed, while the market interest rates change
What does the AAA rating assigned S&P mean?
The firm is in a strong position to meet its debt obligations
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
What does a Moody's bond rating of C typically indicate?
The insurer is in default
What are the three components that influence the Treasury yield curve?
The interest rate risk premium The real rate of return Expected inflation
What does the clean price of a bond represent?
The quoted price, which excludes interest accrued since the last coupon date
Whats is the fisher effect?
The relationship between nominal returns, real returns and inflation.
Which of the following are usually included in a bonds indenture?
The total amount of bonds issued The repayment arrangements
We could also solve this using the growing annuity formula.
The withdrawals are increasing by 4% so we have PV = 26,000 [ (1- (1.04/1.1)^3) / .1-.04] = 26,000 (2.5812) = $67,111.65
Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?
They are default-free, they are taxable, and they are highly liquid
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
what are municipal notes/bonds?
They are short-term securities that are normally issued to assist a municipality in financing a project or in managing its cash flow. almost always callable have default risk coupon exempt from federal ( but not state) taxes.
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
Some projects such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return
True
T/F: The price you actually pay to purchase a bond will generally exceed the clean price
True
In general, the stock market is more transparent than the real estate market.
True, more price and volume info is available
If you incest in a corporate bond, how many times can you expect, in general, to receive interest?
Twice a year
If you invest in a corporate bond, how many times can you expect, in general, to receive interest?
Twice a year
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
Which is the largest security market in the world in terms of trading volume?
US treasuries market
what is the largest securities market in the world?
US treasury market
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
How do we find a bonds yield to maturity?
We must use trial and error, because there is no way to solve for r explicitly. Look at the info we know. the bond is discounted and the coupon is $80 on 1000 face value, that means the interest rate is at more then 8%. go from there to check answers.`
When valuing a stock, the advantage to considering the stock price in the distant future (rather than a more near term price) as a cash flow is that:
When discounted to present value, a stock price in the distant future is nearly zero
A bond has a quoted price of 984.63 a face value of 1,000 a semi-annual of 20 and a maturity of 10 years. Match its current yield to its YTM below.
YTM = 4.19 Current yield = 4.06
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
What is a corporate bond's yield to maturity
YTM is the prevailing market interest rate for bonds with similar features YTM is the expected return for an investor who buys today and holds it to maturity
A bond has a quoted price of $984.63, a face value of $1000, 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%
Will is deciding whether or not to buy Dang Corporation stock, whose current price is 54.95. Dang paid a dividend of 2.17 this year. Will estimate that dividends will grow very quickly, at a rate of 12% for the next four years. After that, he expects the dividend growth rate to fall to 5%. Should Will buy the stock if his required rate of return is 10%?
Yes; using the two stage growth model, the stock value is 58.06
Will is deciding whether or not to buy Dang corporation stock, whose current price is $54.95. Dang paid a dividend of $2.17 this year. Will estimates that dividends will grow very quickly, at a rate of 12%, for the next four years. After that, he expects the dividend growth rate to fall to 5%. Should Will buy the stock if his required rate of return is 10%
Yes; using the two stage growth model, the stock's value is $58.06
What are cross over of spkit rating bonds?
a bond is rating one way by one agency and another way by a different agency
What is a premium bond?
a bond that sells for more than face value
What is a deferred call provision?
a call provision prohibiting the company from redeeming a bond prior to a certain date.
A benchmark PE ratio can be determined using:
a company's own historical PEs The PEs of similar companies
A bonds coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
what is a protective convenant?
a part of the indenture limiting certain actions that might be taken during the term of the loan usually to protect the lenders interests
What is the treasury yield curve?
a plot of yields on treasury notes and bond relative to maturity based on coupon bond yields
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:
a target average accounting return
A project should be ___ if its NPV is greater than zero
accepted
A project should be ___ if its NPV is greater than zero.
accepted
How is debt securities classified?
according to the collateral and mortgages used to protect the binholder
Payback period tells the time it takes to break even in an ___ sense. Discounted payback period tells the time it takes to break even in an ___ or financial sense
accounting; economic
What occurs when the real rate of interest is high?
all interest rates will tend to be higher and vice versa Doesnt determine shape of term structure but does influence overall interest rates!
What is interest rate risk?
all other things equal, the longer the time to maturity the greater the interest rate risk All other things being equal, the lower the coupon rate, the greater the interest rate risk. a relatively small change in interest rate leads to a large change in bond value
What is a call provision?
allows the company to repurchase or call part of the bond issued at stated prices over a specific period. Give corp. the option to repurchase before maturity.
how is the implicit interest determined?
amortizing the loan calculate bonds value at beginning of each year and then find the change in the bond value from year to year appealing because interest rates start off larger and get smaller as they go down.
What is a sinking fund?
an account managed by the bind trustee for early bond redemption begins to pay of bonds/buy back bonds on the market before maturity
What is a debt rating?
an assessment of the creditworthiness of the corporate issuer. Concerned only with default not based on interest rate risk based on how likely a company is to default and the protection against default
How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the projects lifetime
an increase in the size of the first cash inflow will decrease the payback period, all else held constant
What type of loan is a bond usually?
an interest only loan. every payment you are paying the interest and not the principle. when the bond is at maturity, you pay the principle.
what is a debenture?
an unsecured bind for which no specific pledge of property is made holders have a claim only to the property that remains after collateral or mortgage trusts are taken into account.
When is bond trading larger then stock trading?
because, in general, corp have more outstanding bonds then stock
When an investor sells a bond, the price received is always the ___.
bid price
what are convertible bonds?
bonds that can be converted into shares of common stock at some predetermined ration at the discretion of the bondholder
fallen angel?
bonds that drop from higher rating to "junk"
What are municipal bonds?
bonds that have been issued by state or local government
what are warrants?
buyer of bond gets right to purchase stock in company st fixed prices often issued at low coupon rates
Convertible bond
can be exchanged for shares of stock
Which of the following are expected cash flows to investors in stocks?
capital gains, and dividends
The IRR rule can lead to bad decisions when __ or ___.
cash flows are not conventional Projects are mutually exclusive
As an investor in the bond market, why should you be concerned about changes in interest rates?
changes in interest rate cause changes in bond prices
In which of the following scenarios would IRR always recommend the wrong decision?
start CF= 1000 End CF= -2000
The goal of many successful organization is an ___ rate of growth in dividends
steady
The goal of many successful organizations is a(n) ___ rate of growth in dividends.
steady
Positive protective covenants
"thou shalt" it specifies action the company agrees to take or a condition the company must abide by 1. the company must maintain its working capital at or above some specified minimum level 2. the company must periodically furnish audited financial statements to the lender 3. the firm must maintain any collateral of security in good condition
If the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ___.
$1,220
What is the clean price of a 1000 par value bond with a 12 % coupon, payable semiannually, if the bonds dirty price is 1050 and the next semiannual coupon payment is due in 4 months?
$1030
Scott Corporation does not pay dividends. The PE ratio for its industry is 13.3, and Scott's EPS were $1.47. At what price should Scott's stock trade?
$19.55
A firm decides to raise money by issuing 5 million bonds with a par value of $5,000 each for 10 years at a coupon rate of 7 percent. At the time of issue, the bonds were sold for $5,500 each. What will the par value of the bonds be in year 5?
$5,000 per bond; par value is not affected by interest rates, market price, or time.
Dusty Corporation has an issue of preferred stock that pays a dividend of 7% of its state value, which of $100. Which of the following would be a commonly used name for the preferred stock?
$7 preferred
Which of these correctly identify differences between US Treasury bonds and corporate bonds?
-treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer -treasury bonds are considered free of default risk while corporate bonds are exposed to default risk -treasury bonds are issued by the US government while corporate bonds are issued by corporations
When the US government wants to borrow money for the long-term(more than one year) it issues:
-treasury notes -treasury bonds
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?
.07 X (1-.25)= 5.25%
If you are holding a municipal bond that is trading at par to yield 6%, how much will your after-tax yield change if your income tax bracket increases from 15% to 20%. Assume there are no state or local taxes
0%
Formula for Fisher effect?
1 + R = (1+r) * ( 1+h) R is the nominal rate r is the real rate h is the inflation rate
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%
If you invest in a $1,000 corporate bond that has a 9% coupon and makes semi-annual payments, you can expect to receive ______ each 6 months.
1. 9%/2= 4.5% 2. 1000*.045= $45
What are the weaknesses of the payback method?
1. Time value of money principles are ignored 2. Cash flows received after the payback period are ignored 3. the cutoff date is arbitrary
What must the trust company do? (3)
1. make sure the terms of the indenture are obeyed 2. manage the sinking fund 3. represent the bondholders in default -- that is if the company defaults on the payment
Place the following bonds in order of security as defined in the US.
1. mortgage bonds 2. debentures
Both Bond Sam and Bond Dave have 8 percent coupons, make semiannual payments, and are priced at par value. Bond Sam has four years to maturity, whereas Bond Dave has 17 years to maturity. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond Sam and Bond Dave?
1. use =pv in excel -rate= .08/2 -nper= time *2 -pmt always remains the same 2. to calculate % change= change/1000
Bind vs. note?
10 years or less maturity --> note more then 10 years to maturity --> bond
What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?
10%
What is the total return for a stock that currently sells for $100, pays a dividend in one year of $2, and has a constant growth rate of 8 percent?
10%
what is the coupon rate on a bond that has a par value of 1,000, a market value of 1,100 and a coupon interest payment of 100 per year?
10% (100/1000)
If investors require a 10% real rate return and the inflation rate is 8% what must be the approximate nominal rate? The exact nominal rate?
10% + 8 % = about 18% 1+R = 1.1 * 1.08 = 1.188 R= 0.188 18.8%
What is the effective annual yield for a bond that pays interest semiannually and has a quoted yield to maturity of 10 percent?
10.25%
Find YTM on a 20 year, $1,000 par value bond that pays coupons of 4.5% semi annually and currently sells for $1,104.89.
1104.89= 45*((1-(1/1.0375^20)/.0375) + 1000/(1.0375)^20
If the rate of inflation is 3 percent and the real rate of return is 9 percent, the nominal rate is approximately ___ percent.
12
If the rate of inflation is 3% and the real rate of return is 9%, the nominal rate is approximately __ percent
12
If the present value of the interest payments on a bond is 320 and the present value of the par value to be paid at maturity is 900, the total value of the bond must be__.
1220
Scott corporation does not pay dividends. The PE ratio for its industry is 13.3 and Scott's EPS were 1.47. At what price should Scott's stock trade?
19.55 =(13.3*1.47)
Which of the following are mutually exclusive investments?
2 different choices for the assembly lines that will make the same product, & a restaurant or gas station on the same piece of land.
In terms of time of maturity, US Treasury notes and bonds have initial maturities ranging from ___ years.
2 to 30
negative protective covenants?
negative --> "thou shall not" it limits of prohibits actions the companies might take Examples of Negative? The firm must limit the amount of dividend paid according to formula the firm cannot pledge any assets to lenders the firm cannot merge with another firm the firm cannot sell or lease any major assets without approval from lender the firm cannot issue additonal long-term debt
is the bond market transparent?
no transactions are privately negotitated bxt parties
WinWin Corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?
no minority shareholder would have enough votes to win any seat on the board
the difference between the nominal rate and the real rate?
nominal --> percentage change in the number of dollars you had real rate --> the percentage change in how much you buy with your dollars.% change in buying power
Lets say the inflation is 5 percent / year and investment is available that will be worth 115.50 in one year. It it cost 100 today, what is the rate f return?
nominal is 15.5%
In what terms are financial rates, interest rates and discount rates almost always quoted in?
nominal terms (R)
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
When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:
one vote per share held
When voting for the board of directors, the number of votes a shareholders is entitled to is generally determined as follows:
one vote per share held
The constant growth formula calculate the stock price:
one year prior (year t) to the first dividend payment(Dvt+1)
Fundamentally, the business of the NYSE is to attract and process ____.
order flow
what are long term debt securities?
over one year to maturity
What type of market is the bond market? o
over the counter
Put bond
owner can force issuer to repay prior to maturity at a stated price
What is the price of a stock if its dividend a year from now is expected to be $3.20, the discount rate is 9 percent, and the constant rate of growth is 5 percent?
p0= 3.20/(.09-.05)=$80
which of these is included in the calculation of a bond's yield to maturity?
par value, current price, coupon rate
This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively
payback method
The amount of time needed for the cash flows from an investment to pay for its initial cost is the
payback period
The NYSE differs from the NASDAQ primarily because the NYSE has:
physical location specialists an auction market
what is transparency of market?
possible to easily observe its prices and trading volumes
In capital budgeting, the net ____ determines the value of a project to the company
present value
Initial public offerings of stock occur in the ___ market.
primary
Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If Projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?
project beta
What are all long term debt securities?
promises made by the issuing firm to pay principal when due ad to make timely interest payments on unpaid balance
Cat bond
protects insurance companies form natural disasters
What bonds are usually debentures?
public bonds
What are the two main forms of long term debt?
public issue and privately issued directly placed with the lender, not offered to public)
What is the present value of these cash flows in the appropriate nominal discount rate is 10%
pv = 26,000/(1.1) + 27,040/(1.1)^2 + 28,121.6/1.1^3 = $67,111.65 NOTICE WE DISCOUNTED THE NOMINAL CASH FLOWS AT THE NOMINAL RATE
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% paid annually, if the yield on similar bonds is 9%?
pv of coupons= C*((1-(1/1+r^t)/r) =641.77
Approximately the nominal rate is equal to?
r+h
How is APR computed?
rate per period * # periods per year
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
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
If 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
According to the basic IRR rule, we should
reject a project if the IRR is less than the required return
According to the basic IRR rule, we should:
reject a project if the IRR is less than the required return
If the IRR is greater than the ___ ___, we should accept the project
required return
If the IRR os greater than the __ __, we should accept the project
required return
What is debt?
result of borrowing money. must be paid
NPV accounts for the size of the project and thus mitigates the effects of
scale
what are mortgage securities?
secured by a mortgageon the real property of the borrower, the property involved is usually real estate involves a mortgage trust indenture of trust deed
what is bond strictly speaking?
secured debt
what is a bond generally speaking?
secured or unsecured debts
What must the owner of the bond do to receive payments?
send in one of the coupons attached to the bonds to the corporation for payment
What is one type of arrangement for call premium?
set it to the annual coupon rate and the have it become smaller over time (moving toward zero)
The NYSE member who acts as a dealer in a small number of securities is called a(n) _____.
specialist
Mota Motors has eight directors on its board, two of whom go up for election each year. This is an ex of a:
staggered board
Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:
zero
Capital Corp. is considering a project who internal rate of return is 14%. If capital required return is 14%, the NPV is:
zero
If the growth rate (g) is zero, the capital gains yield is ___.
zero
The IRR is the discount rate that makes the NPV of a project equal to ___.
zero
The IRR is the discount rate that makes the NPV of a project equal to ____.
zero
How is a zero coupon bond different form a conventional bond?
zero coupon bonds make no interest payments zero coupon bonds are always issued at a discount
Three special case patterns of dividend growth include:
zero growth constant growth non constant growth