Investments: Bond valuation Flashcards

1
Q

Coupon Rate

A
• periodic interest payment received by a bond holder

- coupon payment entered as a payment on the financial calculator

2
Q

Par Value

A
• principal amount that will be repaid to bond investors at the end of the loan period.
• \$1000 on bond issues unless stated otherwise
3
Q

Length of time to maturity

A
• time remaining until the bond holder receives the par value.
• number of periods or loan will be outstanding
4
Q

Market interest rates

A
• yield currently being earned in the marketplace on comparable securities.
• rate used to discount a bond to determine what it is currently selling for in the market
5
Q

How does a rise in interest rates affect the bond market?

A
• investors can get a larger stream of cash flows (higher coupon) on new bonds from the corporation.
• current bond holders selling bonds must do so at a discount to stay competitive with new bonds
6
Q

How do falling interest rates affect the bond market?

A
• coupon rates on new bonds (constant income stream) from corporations will be less than previous bonds making older bonds worth a premium.
• investors buying these older higher coupon bonds must pay a premium above par value
7
Q

Coupon rate or nominal yield

A

Coupon Rate = coupon payment/par value

8
Q

Current Yield

A

Current Yield = coupon payment/price of the bond

9
Q

Current Yield - Example

A
10
Q

Yield to maturity (YTM)

A
• compounded rate of return if an investor buys a bond today and holds it until maturity.
• assumes that an investor is able to reinvest coupon payments at the yield to maturity rate
• always assume semiannual compounding on the CFP exam unless told otherwise
11
Q

Calculate Bond Holding Period Return

A

**important tested frequently

12
Q

Yield to call (YTC)

A
• compounded rate of return if an investor buys a bond today and the bond is called (retired) by the issuer.
• when calculating:

Use number of periods until bond is called, not until maturity

-use call price, not the par value as FV

13
Q

Yield Summary

A

Premium - YTM and YTC are smallest

Par - all elements are equal

Discount - YTM and YTC are biggest

14
Q

A

If you see a discount “Call Moms Cell Now!”

15
Q

Accrued Interest

A
• when purchasing a bond, buyer pays seller interest that has accrued since last interest payment.
• buyer then received full amount of interest due at next interest payment.
16
Q

What are the yield curve theories

A
1. liquidity preference theory
2. market segmentation theory
3. expectations theory
17
Q

Liquidity Preference Theory

A
• yield curve results in lower yields for shorter maturities, because some investors prefer liquidity. And are willing to pay for liquidity in the form of lower yields.
• long term yields should be higher than short term yields because of added risk associated with longer term maturities.
18
Q

Market Segmentation Theory

A
• yield curve depend on supply and demand at a given maturity. There are markets for each maturity, with buyers and sellers at each maturity.
• supply is greater than demand at a maturity, rates are low. Rates will have to increase to increase demand.
• demand is greater than supply at a maturity, rates are high. Rates will have to decrease to drive down demand.
19
Q

Expectations Theory

A
• yield curve reflects investors inflation expectations.
• since investors are uncertain or believe inflation will be higher in the future, long term yields are higher than short term yields.
• if inflation is expected to be lower in the future, long term rates will be lower than short term rates = inverted yield curve
20
Q

Unbiased expectations Theory

A
• todays longer term interest rates have imbedded in them expectations about future short term interest rates.
• long term interest rates are geometric averages of current and expected future short-term interest rates.
21
Q

Bond Duration

A
• Duration is the weighted average maturity of all cash flows.
• bigger the duration, more price sensitive to interest rate changes.
• duration is the moment in time the investor is immunized from interest rate risk and reinvestment risk
• to be effectively immunized a bond portfolio should have duration equal to the investors time

*formula picture
Horizon.

22
Q

What is modified bond duration?

A

A bonds price sensitivity to changes in interest rates.

23
Q

What is bond durations relationship to the term of the bond?

A
• direct relationship

- term of bond increases, duration increases

24
Q

What is bond durations relationship to yield to maturity and coupon rate?

A
• inverse relationship
• yield to maturity or coupon rate increase, bond duration decreases
• yield to maturity or coupon rate decrease, bond duration increases
• zero coupon bond will always have duration equal to maturity.
25
Q

Bond Duration Calculation Examples

A
26
Q

Estimating Bond Price

A

Duration can be used to estimate price change of a bond, based on a change in interest rates.

27
Q

Duration assumptions

A
• linear relationship between change in interest rates and a bonds price.
• duration does a good job of estimating price change for small interest changes

Bad job of estimating price change for large interest rate changes

-duration understates the price appreciation when interest rates decrease

Overstates the price depreciation when interest rates increase

28
Q

Tax Swap

A

Selling a bond that had a gain and bond that had a loss to offset each other

Or

Selling a bond that has a loss and buying a new bond

29
Q

Barbells

A
• owning both short term and long term bonds

- when interest rates move, only one set of positions need to be sold and restructured

30
Q

A
• purchasing bonds with varying maturities
• bonds mature, new bonds are purchased with longer maturities than what exist in the portfolio.

-helps eliminate interest rate risk since bonds are held until
Maturity

31
Q

Bullets - bond strategy

A
• little payments during the interim period and then a lump sum at some specified date in the future.
• most bonds will mature in or around the same time period.
• zero coupon bonds, treasuries or corporates work for this strategy.
• used when an investor had a balloon payment on a liability in the future
32
Q

Preferred Stock

A

*has both debt and equity features

Debt features:

• stated par value
• stated dividend rate as a percentage of par

Equity features:
Price of preferred stock may move with the price of the common stock.

Differences:

• dividend does not fluctuate
• no maturity date like a bond
• price of preferred stock tied to interest rates not common stock

*corporations received 50-65% deduction of dividends.

33
Q

Convertible Bonds

A
• conversion value is value of convertible bond in terms of the stock in which it can be converted. ￼
• one primary benefits is that if stock does not perform well the investor has a floor built in. Floor is the par value of the bond if convertible held until maturities.
• formula not included on formula sheet need to memorize!!!
34
Q

Property Valuation

A

-use formula to determine how much an investor is willing to pay for a piece of property.

35
Q

Property Value - Net Operating Income example

A