week 4 Flashcards
(9 cards)
How do you calculate bond prices for annual and semi-annual coupons?
Bond price = Present value of coupons + Present value of face value. Use PV of annuity formula for coupons and PV of lump sum for face value. For semi-annual, divide coupon and rate by 2, multiply periods by 2.
How can you classify bonds as discount or premium?
A bond trades at a discount if its price is below face value (coupon rate < market rate), and at a premium if price is above face value (coupon rate > market rate).
What is the formula for bond pricing using present value concepts?
Bond price = (Coupon × [1 - 1/(1 + i)^N]/i) + (Face Value / (1 + i)^N), where i is the discount rate per period and N is number of periods.
How do you calculate the Current Yield of a bond?
Current Yield = Annual Coupon Payment ÷ Current Market Price. It measures the income return relative to the bond’s price.
What is Yield to Maturity (YTM) and how does it differ from Current Yield?
YTM is the total return expected if held to maturity, including coupon payments and capital gains/losses. Current Yield only reflects income, ignoring capital gains/losses.
How does credit risk affect bond yields and yield spreads?
Higher credit risk means higher yield spreads compared to risk-free bonds, compensating investors for default risk. Yield spreads widen during economic stress.
What is the relationship between bond prices and interest rates?
Bond prices and interest rates move inversely: when interest rates rise, bond prices fall, especially for long-term bonds with lower coupons.
Why are long-term bonds more sensitive to interest rate changes?
Longer maturity means future payments are discounted over more periods, increasing price volatility when rates change.
What happens to bond price when the market interest rate exceeds the coupon rate?
The bond sells at a discount because its coupons are less attractive than current rates.
