Finance 3320, Chapter 7
what is the price of a U.S. treasury bond that is listed at 90 if the par value is $1,000?
$900
a corporate bonds yield to maturity___________
- can be greater than, equal to, or less than the bonds coupon rate - changes over time
Name six factors that determine the yield on a bond.
- expected future inflation-default risk-Real rate of return-taxability- interest rate risk- liquidity
as a general rule, which of the following are true of debt and equity?
-equity represents an ownership interest - the maximum reward for owning debt is fixed
Institutions that issue bonds that are traded in the bond market
-public corporations - state governments - federal governments
common protective covenants
-the firm must limit dividends to equity holders - the firm cannot merge with any other firm - the firm must maintain working capital at or above a specified level
Features of municipal bonds
-the interest on municipal bonds is exempt from federal taxes - they are issued by state and local governments
how is zero-coupon bond different from a conventional bond?
-zero coupon bonds make no interest payments - zero coupon bonds are always issued at a discount
match the following terms with the definitions: 1- CAT bond 2- convertible bonds 3- put bond 4- structured note
1- protects insurance companies from natural disasters 2- can be exchanged for shares of stock 3- owner can force issuer to repay prior to maturity at a stated price 4- based on financial securities, commodities, or currencies
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 rates are higher.
The tax-ability premium is the additional compensation demanded on _____.
Taxable bonds
What are some reasons why the bond market is so big?
Various state and local government also participate in the bond market, many corporations have multiple bond issues outstanding, and the federal government borrowing activity in the bond market is enormous.
There is a ___________ relationship between market interest rates and bond values
negative
the rates on financial securities are generally quoted as
nominal rates
which is the largest security market in the world in terms of trading volume?
the U.S. treasuries market
which has a higher value, the bid price quote or the asked price quote?
the asked price quote
what is the bid price?
the bid is the price that the dealer is willing to buy securities
the price that represents what dealer is willing to pay for a security is
the bid price.
if the market rate of interest rises, what will happen to the value of your bond?
the bond will fall
you own two bonds- one with a 5 percent coupon and one with a 6 percent coupon. which one is more sensitive to interest rate risk, all other things being equal
the bond with the 5 percent coupon rate is more sensitive
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 the its "dirty price"?
the clean price excludes interest accrued since the last coupon payment, while the dirty price includes accrued interest.
Why does a bonds value fluctuate over time?
the coupon rate and the par value are fixed, while market interest rates change
why is the YTM of a discount bond greater than the bond's current yield?
the current yield does not include the capital gain from the price discount from face value
fisher effect decomposes the nominal rate into
the inflation rate and the real rate
what does Moody's bond rating of C typically indicate?
the issuer is in default
which of the following is true about interest rate risk (if all else equal)?
the longer the time to maturity, the greater the interest rate risk; the lower the coupon rate, the greater the interest rate risk
three components of the treasury yield curve?
- interest rate risk premium - real rate of return - expected inflation
the three components of the nominal rate of return
- real rate of return - compensation for the inflation effect on the investment earnings - compensation for the inflation effect on the original investment
what information is required to compute a bonds yield to maturity?
- time to maturity - coupon rate - the bonds current price
How is zero-coupon bonds different from conventional bonds?
- zero coupons are always issued at a discount - zero coupon bonds make no interest payments
What are some features of the OTC market for bonds?
-OTC dealers are connected electronically -The OTC has no designated physical location
what is a corporate bonds yield to maturity? (YTM)
-YTM is the expected return for an investor who buys a bond and holds it to maturity - YTM is the prevailing market interest rates for bonds with similar features
which is true about bond face value?
-also known as par value -it is the principal amount repaid at maturity
required to calculate the current value of a bond
-coupon rate -applicable market rate -par value -time remaining to maturity
which variables are required to calculate the value of a bond?
-coupon rate -remaining life of bond -market yield
how has TRACE improved transparency in the corporate bond market?
Corporate bond dealers are now required to report trade info through TRACE
in an inflationary environment, the nominal rate will always be _________ the real rate
GREATER THAN
As the maturity of a bond increases, interest rate risk ___.
Increases at a decreasing rate
what are the sources of information for generating bond ratings?
Information from the corporation being rated, and information collected by the bond rating agency.
What will happen to the default risk premium during periods of economic uncertainty?
It will increase.
How significant is the real rate of return in determining the shape of the term structure of interest rates?
Not very significant and also less significant than inflation.
what are the federal income tax implications of receiving $50 an interest income from a municipal bond versus a corporate bond?
Only the interest on the corporate bond will be taxed.
What are the cash flows involved in the purchase of a 5-year zero-coupon bond that has a par value of $1000 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.
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 rate.
Suppose you own a 30-year bond issued by GE and a 2-year bond issued by PG with identical coupon rates and par values. Which bond will you lose more money on as interest rates rise?
The GE bond will lose more because it has a longer maturity.
A Treasury yield curve depicts the _____
Yields for different maturities of Treasury securities.
what is a discount bonds?
a bond that sells for less than the face value
A bond YTM will exceed its current yield when the bond is selling at...
a discount. YTM will exceed the current yield when a bond sells for less that par value (discount)
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
What are original issue discount bonds?
bonds that are issued with a very low coupon rate
what are municipal bonds
bonds that have been issued by state or local governments
crossover bonds
bonds that have both an investment grade and a junk bond rating
which of the following is include in the calculation of ab bonds yield to maturity?
coupon rate, par value, current price
Which terms apply to a bond?
coupon rate, time to maturity, par value
True or false: The inflation premium will be higher if the rate of inflation is low.
false
the real rate of return will generally be higher than the nominal rate of return
false
the interest from a municipal bond is exempt from _____ income taxes.
federal
According to the approximation formula for the nominal rate of return (R), the nominal rate will ___________ if inflation (h) increases
increase
A bond's yield to maturity considers the interest earnings and the change in the bond's price while the current yield considers_______.
interest earnings only
the relationship between bond prices and the market rate of interest is
inverse; if the market rate of interest rises, the bond prices will fall
definition of a bonds time to maturity
is the number of years until the face value is due to be repaid
what is the nominal rate of return on investment?
is the rate that has not been adjusted for inflation
which of the following is true about a multi-year typical bonds coupon?
its a fixed annuity payment
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 rate
the interest rate risk premium is the additional compensation demanded by investors for holding________ bonds
longer-term
all else held constant, the yield on a highly liquid bond will be _________ the yield on an illiquid bond.
lower than
why is the bond market less transparent than the stock market?
many bond transactions are negotiated privately
the most important source of risk from owning bonds?
market interest rate fluctuations
a sinking fund is one type of ....
repayment provision
in case of default
subordinated debt holders must give preference to other specified creditors
which of the following are usually included in a bonds indenture?
the repayment arrangements. the total amount of bonds issued.
why did Disney issue 100-year bonds, dubbed "sleeping beauty" bonds in the 1990s?
to lock in historically low interest prices
U.S. treasury bonds
treasury binds have no default risk interest from U.S. treasuries is exempt from state level taxes but corporate interest is not
in general the stock market is more transparent than the real estate market
true
If you invest in a corporate bond, how many times can you expect, in general, to receive interest?
two times a year
what will the impact be on your risk exposure if your bond has recently been categorized as a "fallen angel"?
your risk will increase
What are three components determine the shape of the term structure of interest rates?
• Inflation premium• Interest rate risk premium• Real interest rate
