2.8 Bond Valuation 1

Question 1

what are bond ratings about?

Answer 1

• there are firms that RATE CORPORATIONS CREDIT-WORTHINESS
• not going to give firm money if they’re risky
• including:
  fitch, moody’s and standard and poor ( S&P)

Question 2

What is the scale of bond ratings and what does it mean?

Answer 2

AAA, AA, A, BBB, ….B…. where AAA to AA strong, A to BBB medium, C…D is weak

• strong means corporations have the capacity to pay back their debt
• medium means they have capacity, but changes in economic conditions may affect credit worthiness
• weak means corporations are heavily affected by economic conditions or are in default

Question 3

What is the value of a bond?

Answer 3

The value of a bond is equal to the sum of the present values of all interest payments and principal

Question 4

What is a zero coupon bond?

Answer 4

• this bond pays no coupons

- we still pay the face value at maturity

Question 5

What is a discount bond?

Answer 5

A bond that is selling for less its face value e.g. bond is selling for $600 but face value is $1000
- its yield to maturity > coupon rate

Question 6

What is a premium bond?

Answer 6

A bond that is selling for more than its face value

e. g. bond is selling for $12000 but face value is $1000
- YTM

Question 7

What is interest rate risk?

Answer 7

The risk that interest rates fluctuate, therefore changing the value of an asset

Question 8

What is the relevance of maturity for a bond?

Answer 8

All else being equal,

the longer the maturity of a bond the longer the bond’s sensitivity to interest rate risk

Question 9

What is the relevance of the coupon rate for a bond?

Answer 9

All else being equal, the lower the bond rate of a bond => the larger the bond’s sensitivity to interest