Bond Valuation

Question 1

Coupon payments

Answer 1

fixed payments made to the investor every six months

Question 2

Par Value

Answer 2

cash payment made to the investor at the maturity of a bond

Question 3

Bond prices are _____ related to interest rates

Answer 3

negatively related

Question 4

Bond price increases when

Answer 4

the required return is lower

Question 5

Bond prices decrease when

Answer 5

interest rates are higher

Question 6

Bond prices have to incorporate this change in interest rate

Answer 6

to this changed yield – balance

Question 7

where bonds are sold:

Answer 7

primary market
secondary market

Question 8

primary market

Answer 8

sales of newly issued bonds are referred to as primary market transactions
-these bonds are almost always issued at par

Question 9

secondary market

Answer 9

once the bond has been issued, it can be bought and sold on the secondary market

Question 10

prices in the secondary market fluctuate based on

Answer 10

changes in the required return of the bon d

Question 11

prices in the secondary market are quoted per

Answer 11

$100 of bond price

Question 12

source of return in bonds!

Answer 12

1. coupon payments
2. price appreciation
3. reinvestment income

Question 13

coupon payments

Answer 13

contractually required semi-annual payments

Question 14

price appreciation

Answer 14

required return on the bond decreases

Question 15

reinvestment income

Answer 15

reinvesting coupon income

Question 16

sources of risk in bonds!

Answer 16

1. credit risk
2. price decline
3. reinvestment risk

Question 17

credit risk

Answer 17

risk that the investor defaults

Question 18

price decline

Answer 18

required rate on the bond increase, thus lowering the price of outsanding bonds

Question 19

reinvestment risk

Answer 19

interest rates decline, and thus the rate you return on your reinvested coupons declines

Question 20

two components of price risk in bonds

Answer 20

market risk
company specific risk

Question 21

market risk

Answer 21

interest rates in the aggregate increase or average risk premiums increase
- base interest rates (EX: LIBOR, SOFR, Fed Funds Rate) change
- average risk premium on comparably rated bonds change

Question 22

market risk impacts…

Answer 22

ALL issuing entities: changes in base interest rates or average risk premium
* interest rates in economy change, bond in market changes*

Question 23

Company specific risk

Answer 23

the Company is viewed as a higher risk (rating agency downgrade), and thus requires a higher return

idiosyncratic-company specific- apple bond

Question 24

Reasons the Fed Changes Rates

Answer 24

increases in rates
decreases in rates

Question 25

increases in rates

Answer 25

typically used to fight inflation -higher rates lead to higher costs to finance expenditures -this leads to lower aggregate demand in the economy -lower demand, with supply held constant, reduces prices (inflation)

Question 26

increase in rates causes

Answer 26

economic stagnation

Question 27

decreases in rates

Answer 27

typically used to spur the economy -lower rates leads to it being cheaper to borrow money for expenditures (both individuals and corporations) -this leads to increased economic activity

Question 28

decreases in rates can lead to

Answer 28

inflation

Question 29

Bond pricing

Answer 29

-Bonds are issued at par

Question 30

at par:

Answer 30

its price is equal to its face value

Question 31

all bonds are issued at par. meaning that the

Answer 31

coupon payment= required return * par value

Question 32

If the bonds required return decreases,

Answer 32

price increases and thus it is trading at a premium

Question 33

trading at a premium:

Answer 33

its price is greater than face value

Question 34

if the bonds required return increases

Answer 34

price decreases and thus it is trading at a discount