Bond Valuation

Question 1

accrued interest

Answer 1

Interest earned (but not yet paid) on a bond since the previous coupon payment. (Chapter 11)

Question 2

bond equivalent yield

Answer 2

The yield to maturity of a bond calculated by multiplying the six-month yield times two to obtain the annual yield. (Chapter 11)

Question 3

bond ladders

Answer 3

An investment strategy wherein equal amounts of money are invested in a series of bonds with staggered maturities. (Chapter 11)

Question 4

bond swap

Answer 4

An investment strategy wherein an investor simultaneously liquidates one bond holding and buys a different issue to take its place. (Chapter 11)

Question 5

clean price

Answer 5

The price of a bond ignoring any accrued interest. The clean price is the present value of the bond’s future cash flows, not including any interest accruing on the next coupon date. (Chapter 11)

Question 6

current yield

Answer 6

Measure of the annual interest income a bond provides relative to its current market price. (Chapters 10 and 11)

Question 7

dirty price

Answer 7

A bond’s dirty price equals its clean price plus accrued interest. (Chapter 11)

Question 8

duration

Answer 8

A measure of bond price volatility that captures both price and reinvestment risks and that is used to indicate how a bond will react in different interest rate environments. (Chapter 11)

Question 9

expectations hypothesis

Answer 9

Theory that the shape of the yield curve reflects investor expectations of future interest rates. (Chapter 11)

Question 10

expected return

Answer 10

The return an investor thinks an investment will earn in the future. (Chapters 4 and 11)

Question 11

immunization

Answer 11

Bond portfolio strategy that uses duration to offset price and reinvestment effects; a bond portfolio is immunized when its average duration equals the investment horizon. (Chapter 11)

Question 12

liquidity preference theory

Answer 12

Theory that investors tend to prefer the greater liquidity of short-term securities and therefore require a premium to invest in long-term securities. (Chapter 11)

Question 13

market segmentation theory

Answer 13

Theory that the market for debt is segmented on the basis of maturity, that supply and demand within each segment determine the prevailing interest rate, and that the slope of the yield curve depends on the relationship between the prevailing rates in each segment. (Chapter 11)

Question 14

promised yield

Answer 14

Yield to maturity. (Chapter 11)

Question 15

realized yield

Answer 15

Expected return. (Chapter 11)

Question 16

tax swap

Answer 16

Replacement of a bond that has a capital loss for a similar security; used to offset a gain generated in another part of an investor’s portfolio. (Chapters 11 and 17)

Question 17

term structure of interest rates

Answer 17

The relationship between the interest rate or rate of return (yield) on a bond and its time to maturity. (Chapter 11)

Question 18

yield curve

Answer 18

A graph that represents the relationship between a bond’s term to maturity and its yield at a given point in time. (Chapter 11)

Question 19

yield pickup swap

Answer 19

Replacement of a low-coupon bond for a comparable higher-coupon bond in order to realize an increase in current yield and yield to maturity. (Chapter 11)

Question 20

yield spreads

Answer 20

Differences in interest rates that exist among various sectors of the market. (Chapter 11)

Question 21

yield to call (YTC)

Answer 21

The yield on a bond if it remains outstanding only until a specified call date. (Chapter 11)

Question 22

yield to maturity (YTM)

Answer 22

The fully compounded rate of return earned by an investor over the life of a bond, including interest income and price appreciation. (Chapter 11)