Module 5 - Chapter 7

Question 1

Define:

Bond

Answer 1

A contract between two parties:

One is an investor (you) and the other is a company or government agency borrowing the money

Question 2

Define:

Par Value

Answer 2

Face amount; amount paid at maturity

Question 3

Answer:

What do we assume par value to be?

Answer 3

$1,000

Question 4

Define:

Coupon Interest Rate

Answer 4

Stated interest rate

Multiply coupon interest rate by par value to get dollars of interest

Generally fixed

Question 5

Define:

Maturity

Answer 5

Years until a bond must be repaid

Question 6

Answer:

Maturity ______ as time passes

Answer 6

declines

Question 7

Define:

Issue Date

Answer 7

Date when bond was issued

Question 8

Define:

Default Risk

Answer 8

Risk that issuer will not make interest or principal payments

Question 9

Answer:

What is the primary type of risk for a bond?

Answer 9

Default risk

Question 10

Define:

Call Provision

Answer 10

Issuer can refund if rates decline

Question 11

Answer:

A call provision helps the ___(a)___, but hurts the ___(b)___

Answer 11

a. issuer

b. investor

Question 12

Answer:

Once you have calculated the ___(a)___ you no longer need the ___(b)___

Answer 12

a. annuity amount

b. coupon rate

Question 13

Answer:

If the coupon interest rate exactly equals the discount rate, ______

Answer 13

the bond value today will always equal par

Question 14

Define:

Discount Bond

Answer 14

Bond there YTM is greater than (>) coupon interest rate

or (depending on info given)

The calculated present value of the bond is less than par value ($1,000)

Question 15

Define:

Premium Bond

Answer 15

Bond where TYM is less than coupon interest value ($1,000)

Or (depending on info given)

Present value is greater than par value ($1,000)

Question 16

Answer:

If discount rate equals coupon interest rate than the present value is ___(a)___ par value and the bond sells at ___(b)___

Answer 16

a. equal to

b. par value

Question 17

Answer:

If the discount rate is less than the coupon interest rate then present value is ___(a)___ par value and the bond sells at ___(b)___

Answer 17

a. less than

b. premium

Question 18

Answer:

If discount rate (YTM) is greater than coupon interest rate, the present value of the bond is ___(a)___ par value and the bond sells at ___(b)___

Answer 18

a. greater than

b. discount

Question 19

Answer:

The relationship between discount rate and present value is ______

Answer 19

inverse

Question 20

Answer:

If the discount rate goes up, the present value goes ______

Answer 20

down

Question 21

Answer:

If the discount rate goes down, the present value goes ______

Answer 21

up

Question 22

Answer:

The current yield is the ___(a)___ divided by the ___(b)___

Answer 22

a. annual coupon rate

b. current price

Question 23

Answer:

In general, if a bond sells at premium then the coupon rate is ___(a)___ than the discount rate, so ___(b)___ is more likely

Answer 23

a. greater

b. a call

Question 24

Answer:

Discount rate for premium bonds is called _____

Answer 24

YTC - rate to call

Question 25

Answer: Discount rate for discount bonds is ______

Answer 25

YTM - rate to maturity

Question 26

# Define: Risk Free Bonds

Answer 26

no chance of default by the issuer generally are treasury bonds

Question 27

# Define: Risky Bonds

Answer 27

Have a chance of default by the borrower Generally are corporate bonds

Question 28

List: Step in valuing a corporate bond

Answer 28

1. Write down the cash flows 2. Determine appropriate discount rate (Coupon Rate * Par Value) 3. Calculate the PV

Question 29

Answer: How do you determine the appropriate discount rate of a bond?

Answer 29

Coupon Rate * Par Value

Question 30

Answer: Discount rate on a corporate bond should be ___(a)___ than a treasury bond with the same ___(b)___ because corporate bonds carry ___(c)___

Answer 30

a. higher b. maturity c. default risk

Question 31

Answer: Discount rate of corporate bonds is ______ discount rate of treasury bonds

Answer 31

greater than

Question 32

Answer: Why is the discount rate of corporate bonds greater than the discount rate of treasury bonds?

Answer 32

Because corporate bonds care default risk

Question 33

# Define: Default Risk

Answer 33

Risk that the borrower (usually corporation) may not make all scheduled payments

Question 34

# Define: Yield Spread between Treasury and Corporate Bonds

Answer 34

The difference in yield to maturity between two bonds or classes of bonds with similar maturity

Question 35

Answer: With semiannual bonds, how do you calculate n?

Answer 35

multiply years by 2

Question 36

Answer: With semiannual bonds how do you get periodic rate?

Answer 36

Divide nominal rate by 2

Question 37

Answer: With semiannual bonds, how you get PMT?

Answer 37

Divide annual r (interest earned) by 2

Question 38

Acronym: rd (component of required rate of return)

Answer 38

required rate of return on debt security

Question 39

Acronym: r* (component of required rate of return)

Answer 39

real risk free rate

Question 40

Acronym: IP (component of required rate of return)

Answer 40

inflation premium

Question 41

Acronym: DRP (component of required rate of return)

Answer 41

default risk premium

Question 42

Acronym: LP (component of required rate of return)

Answer 42

liquidity premium

Question 43

Acronym: MRP (component of required rate of return)

Answer 43

maturity risk premium

Question 44

Answer: Maturity risk premium is a _______

Answer 44

period of time

Question 45

# Define: Liquidity Premium

Answer 45

how easy it is to sell or buy a bond

Question 46

# Define: Default Risk Premium

Answer 46

Probability firm will no be able to make payments

Question 47

# Define: The Fisher Effect

Answer 47

defines the relationship between real rate, nominal rates, and inflation

Question 48

Acronym: R (The Fisher Effect)

Answer 48

nominal rate

Question 49

Acronym: r (The Fisher Effect)

Answer 49

real rate

Question 50

Acronym: h (The Fisher Effect)

Answer 50

expected inflation rate

Question 51

AnswerL Because the real rate of return and expected inflation rate are relatively high, there is _______

Answer 51

significant difference between the actual Sigher Effect and the approximation

Question 52

# Define: Reinvestment Rate Risk

Answer 52

The risk CFs will have to be reinvested in the suture at lower rates, reducing income

Question 53

AcronymL MRP

Answer 53

Maturity Risk Premium

Question 54

# Define: MRP Long Term Bonds

Answer 54

High interest rate risk, low reinvestment rate risk

Question 55

# Define: MRP Short Term Bonds

Answer 55

Low interest rate risk, high reinvestment rate risk

Question 56

Answer: Yields on longer term bonds are usually ___(a)___ than on shorter term bonds, so the MRP is ___(b)___ on longer term bonds

Answer 56

a. greater | b. more affected by the interest rate risk than by reinvestment rate risk

Question 57

Answer: With long term bond MRP interest rate risk ___(a)___ and reinvestment rate risk ___(b)___, so yields are usually ___(c)___

Answer 57

a. increases b. decreases c. higher

Question 58

Answer: With short term bond MRP interest rate risk ___(a)___ and reinvestment rate risk ___(b)___, so yields are usually ___(c)___

Answer 58

a. decreases b. increases c. lower

Question 59

# Define: Term Structure of Interest Rates

Answer 59

the relationship between interest rates (or yields) and maturities

Question 60

# Define: Yield Curve

Answer 60

A graphical representation of the term structure