Finance UNIT 5 Bonds
The model that precisely specifies the relationship between the nominal rate and the real rate is: R = the nominal rate r = the real rate h = the rate of inflation
(1 + R) = (1 + r)×(1 + h)
A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a _________________.
call provision
Debt cannot be subordinated to........
equity
True or false: The dirty price does not include accrued interest.
false
A limitation of bond ratings is that they ____.
focus exclusively on default risk
Junk bonds have the following features:
They are rated below investment grade bonds
Which of these correctly identify differences between U.S. 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.
What is a real rate of return?
-It is a percentage change in buying power. -It is a rate of return that has been adjusted for inflation.
What is a real rate of return?
-It is a rate of return that has been adjusted for inflation. -It is a percentage change in buying power.
What are the three components that influence the Treasury yield curve?
-The real rate of return -The interest rate risk premium -Expected future inflation
What is the definition of a bond's time to maturity?
It is the number of years until the face value is paid off
If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?
10 years
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
As an investor in the bond market, why should you be concerned about changes in interest rates?
Changes in interest rates cause changes in bond prices.
The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?
Coupon rate Time to maturity
What is a bond's current yield?
Current yield = Annual coupon payment/Price
Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact Treasury bond yields?
Default risk premium Liquidity premium
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
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.
Which of the following are true about a bond's 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
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately.
Which of the following are bonds that have actually been issued?
a CoCo bond a convertible bond a put bond
A bond's coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
A corporate bond's yield to maturity:
is usually not the same as a bond's coupon rate changes over time
What will happen to a bond's time to maturity as the years go by?
it will decline
The interest rate risk premium is the additional compensation demanded by investors for holding ____ bonds.
longer-term
Equity represents a........................... interest of a firm.
ownership
A part of the indenture limiting certain actions during the term of the loan are termed ________.
protective covenants
The term structure of interest rates examines the ____.
relationship between short-term and long-term interest rates
The term structure of interest rates describes ________.
the relationship between nominal rates and time to maturity the pure time value of money
If a $1,000 par value bond is trading at a premium, the bond is:
trading for more than $1,000 in the market
When long-term rates are higher than short-term rates, which of the following shapes will the term structure of interest rates usually have?
upward sloping
What is the nominal rate of return on an investment?
It is the actual percentage change in the dollar value of an investment unadjusted for inflation.
What is the inflation premium?
It is the additional return demanded by investors to compensate for expected inflation
Which of the following are usually included in a bond's indenture?
The repayment arrangements The total amount of bonds issued
Which of the following are features of municipal bonds?
They are issued by state and local governments. The interest on municipal bonds is exempt from federal taxes. The interest on municipal bonds is, in some cases exempt from state taxes in the state of issue.
What are the two unique features of a U.S. federal government bond?
U.S. Treasury issues are considered to be default-free. U.S. Treasury issues are exempt from state income taxes.
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.
The bid-ask spread represents the ___.
dealer's profit
A key difference between interest payments and dividend payments is?
dividends are not tax deductible interest is tax deductible
Which three of the following are common shapes for the term structure of interest rates?
humped upward sloping downward sloping
What is the bid price?
-It is the price an investor will receive if he sells a bond to a dealer. -It is the price at which a dealer is willing to buy securities.
What is the asked price?
-It is the price at which a dealer is willing to sell a particular security. -It is the price at which an investor can buy a particular security from a dealer.
What does the dirty price represent?
It includes the quoted price and accrued interest
Which of the following are true about a bond's face value?
It is also known as the par value. It is the principal amount repaid at maturity.
What is a bond's accrued interest?
It is interest that has been earned but not yet received by the current bondholder
Which one of the following is the most important source of risk from owning bonds?
Market interest rate fluctuations
Which of the following terms apply to a bond?
Par value Time to maturity Coupon rate
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
Which three components determine the shape of the term structure of interest rates?
Real interest rate Interest rate risk premium Inflation premium
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.
What are some features of the OTC market for bonds?
The OTC has no designated physical location. OTC dealers are connected electronically.
To find the total bond value, add the present value of the amount paid at maturity to the _____ of the annual coupon payments.
annuity present value
If bonds for AT&T are quoted at 115, they can be purchased:
at 115% of par value plus accrued interest
If a $1,000 face value U.S. Treasury bond is quoted at 99.5, then the bond can be purchased _____.
at 99.5 percent of face value plus any accrued interest
If you are holding two bonds - one with a 5% coupon rate and the other with an 8% coupon rate - which one is more sensitive to interest rate risk, all other things being equal?
the 5% coupon rate
Bond ratings are based on the probability of default risk, which is the risk that ___.
the bond's issuer may not be able make all the required payments