2.2.1.3. Valuing Bonds

Question 1

Definition | Maturity Date

Answer 1

final payment date

Question 2

Definiton| Term of the bond

Answer 2

the time remaining until the repayment date

Question 3

Definition | Coupons

Answer 3

the promised interest payments of a bond

Question 4

Definition | Face Value (FV)

Answer 4

the notional amoint we use to compte the interest payments

Question 5

Definition | Yield to Maturity (YTM)

Answer 5

IRR - Internal Rate of Return - of an investment in an bond

Question 6

Definition | Coupon Payment (CPN)

Answer 6

Coupon Rate * Face Value / Number of COupon Payments per Year

Question 7

What is a Zero Coupon Bond?

1.
2.
3.

Answer 7

• a bond that does not make coupon payments
• they trade at a discount in oder to compensate for the missing coupon payments
• also called pure discount bonds

Question 8

Zero Coupon Bonds | The IRR of an investment in an bond is given a special name, the…

1.
2.
3.
4.

Answer 8

• Yield to Maturity (YTM) of just the yield (y)
• YTM of a bond is the discount rate that sets the present value of the premised bond payments equal to the current market price P of the bonds
• the risk-free interest rate equals the yield of a default-free bond
• yield curve also referred to as the zero coupon yield curve

Question 9

Coupon bonds…

Answer 9

…pay face value at maturity and make regular coupon interest payments

Question 10

The yield to maturity y for a bond is…

1.
2.

Answer 10

… the IRR of investing in the bond and holding it to maturity
… the single discount rate that equates the present value of the bond´s remaining cash flows to its current price

Question 11

1. When calculating the yield to maturity of a coupon bond, we compute…
2. This yield is typically….

Answer 11

1. … the yield that will be a rate per coupon interval
2. …stated as an annual rate by multiplying it by the number of coupons per year, thereby converting it to an APR with the same compounding interval as the coupon rate

Question 12

Discounts and Premiums

1.
2.

Answer 12

1. coupon bonds may trade at a discount, at a premium (a price greater than their face value) or at par (price equal to their face value)
2. most issuers of bonds choose a coupon rate so that the bonds will initially trade at or very close to par

(zero-coupon rates at discount, prior to maturity, their price is less than their face value)

Question 13

As Interest rates in the economy fluctuate, the yields that investors demand to invest in bonds…

Answer 13

… will also change

Question 14

A higher yield to maturity implies….

Therefore, as interest rates and bond yields rise, bond prices…

Answer 14

…. a higher discount rate for a bonds remaining cash flows, reducing their present value and hence the bonds price

… will fall, and vice versa

Question 15

Corporate bonds are…

Answer 15

… bonds issues by corporations

Question 16

Corporate bonds and Credit Risk

Answer 16

Credit risk is the risk of default, i.e. the issuer might not pay back the full amount promised in the bond prospectus

Question 17

The yield to maturity of a defaultable bonds….

Answer 17

…exceeds the expected return of investing in the bonds

Question 18

The bonds expected return is equal to…
and…
Moreover, a higher yield to maturity…

Answer 18

….the firms debt cost of capital
…. is less than the yield to maturity if there is a risk of default
…. does not necessarily imply that a bonds expected return is higher

Question 19

Investment Grade Rating

1.
2.

Answer 19

• important for company
• harder time to get funding if only spectulative

Question 20

Investment Grade Bonds

1.
2.

Speculative Bonds
1.
2.

Answer 20

1. bonds in the top four categories
2. low-default risk
3. aka junk-bonds or high-yield bonds
4. likelihood of default is high

Question 21

Rating of Bonds depends on…

Thus, debt issues with a low-.priority claim in bankruptcy…

Answer 21

• risk of bankruptcy as well as the bondholders ability to lay claim to the firms assets in the event of such bankruptcy
• will have a lower rating than issues from the same company that have a high-priority claim in bankruptcy of that are backed by specific asset such as a building or a plant

Question 22

Ofter, insitutional investors are only allowed to buy…
This usually leads to…

Answer 22

…. investmanet grade bond
… a sharp increase in financing costs as soon as a company no longer qualifies as “investment-grade”

Question 23

Default Spread / Credit Spread | Definition

1.
2.
3.

Answer 23

1. the difference between the yields of the corporate bonds and the treasury yields
2. credit spread is high for bonds with low ratings and therefore a greater likelihood of default
3. the delta gets bigger, bc the longer you lend the more time to mess up/ the higher the risk