Bond Valuation

Question 1

How do you value “any asset”?

Answer 1

To value any asset, discount expected future cash flows back to present at an appropriate, risk-adjusted rate.

Question 2

How do you value “any asset”?

Answer 2

To value any asset, discount expected future cash flows back to present at an appropriate, risk-adjusted rate.

Question 3

What are the two cash flows associated with a bond called?

Answer 3

Coupon payments Maturity payment

Question 4

What is the maturity payment?

Answer 4

The payment that occurs at the maturity of the bond. It is the face value of the bond.

Question 5

What is the maturity payment?

Answer 5

The payment that occurs at the maturity of the bond. It is the face value of the bond.

Question 6

What is the valuation formula for a zero coupon bond?

Answer 6

V=Cashflow/(1+kd)^T kd is the risk adjusted rate The cashflow is the maturity payment T is the time of the maturity payment

Question 7

What is another name for a bond’s IRR

Answer 7

It’s “yield-to-maturity”

Question 8

What is the formula for the asked-yield of a treasury bill?

Answer 8

Asked-Yield = (365/days-to-maturity)*IRR

Question 9

What is the formula for the asked-yield of a treasury bill?

Answer 9

Asked-Yield = (365/days-to-maturity)*IRR

Question 10

In the US, how often are coupons typically paid on a bond?

Answer 10

Semi-Annually

Question 11

If a bond pays coupons at 10% and has a face value of $100, how much does it pay each year?

Answer 11

$10 In the U.S. this would be $5 twice a year.

Question 12

What is the value formula for a coupon bond?

Answer 12

B0=C*ADF(kd,maturity)+face_value/(1+kd)^maturity

Question 13

What is the value formula for a coupon bond?

Answer 13

B0=C*ADF(kd,maturity)+face_value/(1+kd)^maturity

Question 14

What does it mean for a bond to be trading at a premium?

Answer 14

The bond is trading at a rate that is above its face value

Question 15

What does it mean for a bond to be trading at a discount?

Answer 15

The bond is trading at less than its face value

Question 16

If a bond is trading at its face value, what would we call it?

Answer 16

Trading at par

Question 17

What is the general formula for pricing any bond?

Answer 17

Question 18

If required interest rates increase bond price will…

Answer 18

Decrease

Question 19

What is interest rate risk?

Answer 19

Risk associated with losing value on a bond because the required interest rate in the market goes up.

Because of the fact that this change happens at different points on the timeline the overall average return (if held to maturity) may be different than the true return due to time value of money.

Question 20

Are low or high coupon bonds more sensitive to interest rate risk?

Answer 20

Low coupon bonds are more sensitive.

Because the maturity payment of the bond is further out compared to coupons, it is more sensitive to changes in the interest rate. When a bond has low coupons, more of its value is tied to that maturity payment and thereby it is more sensitive to interest rate changes.

Question 21

Are long maturity or short maturity bonds more sensitive to interest rate risk?

Answer 21

Long maturity

Because long maturity bonds have more compounding periods ahead of them, changes in interest rates have a larger impact.

Question 22

If a bond has a discount of 0.6 what is its interest rate?

Answer 22

0.6%