Chapter 7 Learn

What are the two major forms of long-term debt?

-private issue -public issue

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%

As an investor in the bond market, why should you be concerned about changes in interest rates?

Changes in interest rates cause changes in bond prices.

What is a bond's current yield?

Current yield = annual coupon payment / current price

What is a discount bond?

Discount bonds are bonds that sell for less than the face value

How is investing in U.S. Treasury bonds different from investing in corporate bonds?

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

Which one of the following is the most important source of risk from owning bonds?

Market interest rate fluctuations

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

Remaining life of bond Coupon rate Market yield

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

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

bought and held to maturity

A bond with exotic features is often called a _____ bond.

cat

The _____ yield is the bond's annual coupon divided by its price.

current

With _____-rate bonds, the coupon payments are adjustable.

floating

A limitation of bond ratings is that they ____.

focus exclusively on default risk

Longer-term bonds have _____(smaller/greater) interest rate sensitivity because a _____(smaller/larger) portion of a bond's value comes from the face amount.

greater, larger

The relationship between bond prices and the market rate of interest is ____.

inverse; if the market rate of interest rises, bond prices will fall

The U.S. Treasuries market is the _____ in the world in terms of trading volume.

largest

The degree of interest rate risk depends on ____.

the sensitivity of the bond's price to interest rate changes

Most of the time, a floating-rate bond's coupon adjusts ____.

with a lag to some base rate

In general, a corporate bond's coupon rate ____,

is fixed until the bond matures

True or false: The inflation premium will be higher if the rate of inflation is low.

False

Which one of these correctly specifies the relationship between the nominal rate and the real rate?

(1 + R) = (1 + r) × (1 + h)

CAT bond Convertible bond Put bond Structured note

- Protects insurance companies from natural disasters - Can be exchanged for shares of stock - Owner can force issuer to repay prior to maturity at a stated price - Based on financial securities, commodities, or currencies correct

A corporate bond's yield to maturity ____.

-changes over time -can be greater than, equal to, or less than the bond's coupon rate

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 is true about interest rate risk?

All else equal, the lower the coupon rate, the greater the interest rate risk. All else equal, the longer the time to maturity, the greater the interest rate risk.

Which is the largest security market in the world in terms of trading volume?

The U.S. Treasuries market

What does a bond's rating reflect?

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

Why does a bond's value fluctuate over time?

The coupon rate and par value are fixed, while market interest rates change.

What does the clean price for a bond represent?

The quoted price, which excludes interest accrued since the last coupon date

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

The total amount of bonds issued The repayment arrangements

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

Time remaining to maturity Par value Applicable market rate Coupon rate

Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?

Treasury bonds are issued by the US government while corporate bonds are issued by corporations. Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer.

The main reason it is important to distinguish between debt and equity is that the benefits and risks _____.

are different

In financial markets the difference between the _____ price and the ask price is known as the spread.

bid

When a corporation or government wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities that are generically called _____.

bond

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

The written agreement between the corporation and the lender detailing the terms of the debt issue is the _____ .

indenture

The Fisher effect decomposes the nominal rate into:

inflation and real rate

The _____ premium is the portion of a nominal interest rate that represents compensation for expected future _____.

inflation, inflation

The federal government can raise money from financial markets to finance its deficits by ___.

issuing bonds

If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ______ $1,000.

less than

If the term structure of interest rates is upward sloping, then ____.

long-term rates are higher than short-term rates

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

A zero coupon bond is a bond that ____.

makes no interest payments

If a given set of cash flows is expressed in _____ terms and discounted at the _____ rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the real rate.

nominal, nominal

The two major forms of long-term debt are _____ issue and privately placed.

public

If a given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ____ rate.

real

Within the context of financial markets, complete the following equation: Bid − Ask = Bid-Ask _____.

spread

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

Equity is publicly traded while debt is not

True or false: A bond's value is not affected by changes in the market rate of interest.

False

True or false: The real rate of return will generally be higher than the nominal rate of return.

False

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

Federal government borrowing activity in the bond market is enormous. Various state and local governments also participate in the bond market. Many corporations have multiple bond issues outstanding.

What are three important features of Treasury notes and bonds?

Highly liquid Default-free Taxable

What is a real rate of return?

It is a rate of return that has been adjusted for inflation.

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

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

decrease

In terms of time to maturity, U.S. Treasury notes and bonds have initial maturities ranging from ___ years.

2 to 30

Which shape does the term structure of interest rates usually have?

Upward sloping

When the U.S. government wants to borrow money for the long-term (more than one year) it issues:

Treasury notes Treasury bonds

The U.S. government borrows money by issuing:

Treasury notes Treasury bonds Treasury bills

True or false: Equity represents an ownership interest.

True

True or false: Interest earned on Treasury notes and bonds is taxable

True

True or false: The major difference between Western financial practices and Islamic law is that Islamic law does not permit charging or paying interest.

True

True or false: The price you actually pay to purchase a bond will generally exceed the clean price.

True

Which of the following is not one of the six factors used to determine the yield on a bond?

Voting rights

What is a corporate bond's yield to maturity (YTM)?

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.