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Finance 2B > 7) Bond yields and types of yields > Flashcards

7) Bond yields and types of yields Flashcards

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1
Q

Why are yields important? (3)

A
  1. A yield is a way of measuring the value of a bond which is better than a price because a yield
    allows us to compare other instruments and against inflation.
  2. A yield allows us to calculate it (incorporate) based on your preferences.
  3. Sometimes quoted in prices and need to calculate yields.
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2
Q

What is YTM?

A

The required rate of return on a bond helt to maturity

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3
Q

The annual interest rate that makes the present value of a bond’s payments equal to its price, assuming? (3)

A
  • Bond is held to maturity.
  • All cashflows are received (coupons and or face value)
  • Coupons are reinvested at the YTM.
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4
Q

True or false, To realize the same percent every year you need to follow the exact same assumptions. These assumptions are unrealistic.

A

True

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5
Q

How is the effective annual yield calculated?

A
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6
Q

What does the YTM consider? (3)

A
  • Income from coupon cash flows.
  • Capital gains or loss
  • Reinvestment income, how-we can prove this manually
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7
Q

Under what circumstances is the YTM reliable? (3)

A
  1. When the coupons are reinvested at an interest rate similar to the yield-to-maturity
  2. When the bond is held to maturity
  3. If the issuer does not default or if all the cashflows are received
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8
Q

What is the current yield?

A

It is the income yield and it only considers coupon flows

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9
Q

How is current yield calcualted?

A
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10
Q

What does current yield ignore?

A
  • capital gains/losses
  • -reinvestment income
  • time value of money.
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11
Q

Therefore current yield has:
- ___________ usefulness
- Suitable for __________ investors

A

limited
income

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12
Q

What if the current yield is < YTM then? (3)

A
  • Bond trading at a discount
  • Current yield will be lower as discount bond takes account of capital gains (Sold below par value.)
  • Because bond prices & yields are inversely related
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13
Q

What if the current yield is > YTM then? (2)

A
  • Bond trading at a premium
  • Current yield will be higher as premium bond takes account of capital losses (Sold above par value.)
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14
Q

What is the relationship between the coupon rate and the yield rate?

A
  • When a bond is trading at a premium the coupon rate is higher than the current yield.
  • Because the coupon rate is calculated as the coupon divided by the par value which lower than the price while the current yield is calculated as the coupon amount divided by the price which is higher than the par value (2)
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15
Q

How is the yield to call calculated? (2)

A
  • Time until call replaces time to maturity (𝑡 = time to call)
  • Call price replaces par value.
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16
Q

What does yield to call assume? (3)

A
  • Bond is called.
  • Bond is held to (first) call date.
  • Coupons can be reinvested at the yield to call up to the call date.
17
Q

What does yield to call consider? (3)

A
  • Coupon flows up to the call date.
  • Capital gains and losses
  • Reinvestment income up to the call date
18
Q

When do you use yield to call?

A

NB: Use if there is a high likelihood that the bond will be called

19
Q

How is holding period return calcualted?

A
20
Q

What are the strengths of Holding period return? (3)

A
  • Accounts for capital gains or losses and coupon income
  • It can be forward looking, just like the YTM
  • It addresses one of shortcoming of the YTM (Holding the bond to maturity)
21
Q

What are the weaknesses of holding period return? (2)

A
  • Ignores time value of money
    -reinvestment of coupons
22
Q

What is realized compound return ?

A

Rate of return actually earned on a bond given the reinvestment of the coupons at varying rates.

23
Q

How is RCY calcualted?

A
24
Q

When reinvestment rate of coupons = YTM → RCY = _____

A

YTM

25
Q

What are the strengths of RCY? (2)

A

It addresses the weaknesses of YTM as it does not have restrictive assumptions.
It accounts for:
- Time value of money (unlike HPR)
- Accounts for reinvesting coupons at different rates

Finance 2B (14 decks)

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