Valuing Bonds Flashcards
(13 cards)
A bond has a coupon rate of 6%, a YTM of 5%, and a par value of $1,000. Is it trading at a premium, par, or discount? Why?
Premium. The bond trades above par because its coupon rate (6%) > YTM (5%), making its fixed payments more valuable than new bonds issued at the lower market rate.
What are the key differences between bonds and equities?
Bonds: Debt instruments, lower risk, fixed returns (interest), higher priority in bankruptcy, fixed maturity. Equities: Ownership instruments, higher risk, variable returns (dividends/capital gains), last priority in bankruptcy, no maturity.
What is the formula to calculate the price of a zero-coupon bond?
PV=FV(1+r)^N
Where: FV = Face value, i = Periodic interest rate, N = Total compounding periods.
A 20-year bond with a 5% coupon and a 10-year bond with a 5% coupon both have a YTM of 6%. Which bond’s price is more sensitive to interest rate changes? Why?
The 20-year bond is more sensitive. Longer maturity bonds have higher duration, meaning their prices are more volatile when interest rates change. Both bonds have the same coupon rate and YTM, but the 20-year bond’s cash flows are received further in the future, making its present value more affected by discount rate changes.
What is the relationship between bond prices and interest rates?
Inverse relationship. When interest rates rise, bond prices fall, and vice versa.
What are the three main types of bond yields?
- Yield to Maturity (YTM): Total return if held to maturity. 2. Yield to Call (YTC): Return if called early. 3. Current Yield: Annual coupon ÷ current price.
How do you calculate the current yield of a bond?
Current Yield = Annual Coupon Payment / Bond Price
Example: 8.15% coupon bond priced at 94.30 → 8.15 ÷ 94.30 = 8.6%.
What is the price of a 5-year zero-coupon bond ($1,000 par) with a 7.5% market rate (semi-annual compounding)?
PV = 1,000 / (1.0375)^10 = $692.04
What determines whether a bond trades at a premium, par, or discount?
- Premium: Coupon rate > YTM. - Par: Coupon rate = YTM. - Discount: Coupon rate < YTM.
What is interest rate risk, and how does maturity affect it?
Definition: Risk that bond prices fluctuate due to interest rate changes. Maturity Impact: Longer maturity = higher interest rate risk.
What are investment-grade vs. junk bonds?
- Investment Grade: Rated BBB-/Baa3 or higher (lower risk). - Junk Bonds: Rated BB+/Ba1 or lower (higher risk, higher yield).
If the Bank of England cuts interest rates, what happens to UK government bond prices?
Prices rise. Existing bonds with higher coupons become more attractive.
What is a bond indenture agreement?
A legal contract specifying bond terms (issuer, coupon rate, maturity, collateral, covenants).
