chapter 5

Question 1

zero-coupon bond

Answer 1

a bond that does not pay coupons.

Question 2

annual percentage rate (APR)

Answer 2

indicates the amount of simple interest earned in one year. that is, the amount of interest earned without the effect of compounding. because of this, the APR quote is typically less than the actual amount of interest you will earn.

Question 3

effective annual rate (EAR)

Answer 3

indicates the actual amount of interest that will be earned at the end of one year.

Question 4

increasing (steep) yield curve

Answer 4

has long-term interest rates much higher than short-term rates. this generally indicates that interest rates are expected to rise in the future.

Question 5

decreasing (inverted) yield curve

Answer 5

has long-term rates lower than short-term rates. this generally signals an expected decline in future interest rates. the shape of the yield curve is strongly influenced by interest rate expectations.

Question 6

coupon bond

Answer 6

coupon bond pays coupon every period (annuity).

Question 7

discount bond

Answer 7

when the price of the zero-coupon bond is lower than the future value.

Question 8

compound rate

Answer 8

r

Question 9

compound factor

Answer 9

(1 + r)

Question 10

early annuity

Answer 10

means that it starts earlier than what is normal for the formula.

Question 11

late annuity

Answer 11

means that it starts later than what is normal for the formula.

Question 12

risky cash flow

Answer 12

variation in future expected cash flows.