Bond Valuation (Lesson 6) Flashcards
What is the coupon rate of a bond
- the periodic interest payment received by a bond holder
What is the par value of a bond
- the principal amount which is $1,000 on bond issues unless stated otherwise
- Amount that will be repaid to bond investors at the end of the loan period
What is the length of time to maturity of a bond
- the time remaining until the bond holder receives the par value
- Number of periods to maturity or that the loan will be outstanding
What is the market interest rate of a bond
- is the yield that is currently being earned in the marketplace on comparable securities
- Rate that is used to discount a bond to determine what is currently selling for in the market
Do changes in interest rates in the marketplace affect the coupon payment
No
Rising interest rates in the marketplace means than old issued bonds will sell at a
discount
Falling interest rates in the marketplace means that old issued bonds will sell at a
premium
How do you calculate the coupon rate of the bond
- Coupon rate = Coupon payment / Par
How do you calculate the current yield of a bond
- Current yield = Coupon payment / Price of bond
What is the yield to maturity of a bond
- essentially the compounded rate of return if an investor buys a bond today and holds it until maturity
- Assumes that the investor is able to reinvest the coupon payment at the yield to maturity rate
What is the yield to call of a bond
- the compounded rate of return if an investor buys a bond today and the bond is called by the issuer
Bonds selling at a discount put the below in order from smallest to largest
Yield to Maturity
Current Yield
Yield to Call
Nominal Yield
- Nominal yield
- Current yield
- Yield to Maturity
- Yield to Call
Bonds selling at a Premium put the below in order smallest to largest
Yield to Maturity
Current Yield
Yield to Call
Nominal Yield
- Yield to call
- Yield to maturity
- Current yield
- Nominal yield
Does the coupon rate change whether a bond sells at a premium or discount
- No stays consistent
What is accrued interest
- when purchasing a bond the buyer pays the seller interest that has accrued since the last interest payment
- Buyer will receive a 1099 INT that reflects the full periods interest received however the buyer is entitled to a deduction equal to the amount of accrued interest paid to the seller
What type of account should treasury zero coupon bonds be held in
- IRA because the bond pays phantom income
- The IRA will not require the recognition of the phantom income
(Yield Curve Theories)
Liquidity Preference Theory
- yield curve results in a lower yield for shorter maturities
- investors prefer liquidity and are willing to pay for liquidity in the form of lower yields
- States long term yields should be higher than short term yields because of the added risk
(Yield Curve Theories)
Market Segmentation Theory
- Yield curve depends on supply and demand at a given maturity and there are distinct markets for given maturities with distinct buyers and sellers at each maturity
- When supply is greater than demand at a given maturity rates are low (Rates will then have to increase for demand to increase)
- When demand is greater than supply at a given maturity rates are high (Rates will then begin to decrease to drive demand down)
(Yield Curve Theories)
Expectations Theory
- Yield curve reflects investors inflation expectations
- since investors are uncertain or believe inflation will be higher in the future long term yields are higher than short term yields
- When inflation is expected to be lower in the future the yield curve will be inverted
What is the unbiased expectations theory
- related to the term structure of interest rates
- holds that today’s long term interest rates have imbedded in them expectations about future short term interest rates
- Long term rates are geometric averages of current and expected future shorter term interest rates
What is duration
- the weighted average maturity of all cash flows
- larger the duration the more price sensitive or volatile the bond is to interest rate change
- When investor is immunized from interest rate and reinvestment rate risk
- Duration should equal the investors time horizon
What is the duration of a zero coupon bond
- duration equals its maturity
As the coupon rate increases the duration
- decreases
As yield to maturity increases the duration
- decreases
In the duration formula on the CFP formula sheet:
D = (1 + y / y) - {(1+y) + t(c-y)}/c{1 + y)t - 1 } +y
What is y? What is c? What is t?
- y = yield to maturity of the bond
- c = Coupon rate of the bond
- t = Number of periods to maturity
How are y, c, and t adjusted in the duration formula if compounding is semiannual
- Divide y and c by 2
- Multiply t by 2
What does duration assume
- that there is a linear relationship between a change in interest rates and a bonds price change (Actually though the relationship is a curve linear)
What is convexity
- is a concept that actually measures the difference in price between what duration estimates and the actual price change of a bond
Does duration understate or overstate the price appreciation when interest rates decrease
- understates
Does duration understate or overstate the price appreciation when interest rates increase
- overstates
(Bond Strategies)
Tax Swap
- involves selling a bond that has a gain and a bond that has a loss which offset each other
- involves selling a bond that has a loss position and just buying a new bond
(Bond Strategies)
Barbells
- involves owning both short term and long term bonds
- when interest rates move only one set of positions needs to be sold and restructured
(Bond Strategies)
Laddered Bonds
- requires purchasing bonds with varying maturities
- as bonds mature, new bonds are purchased with longer maturities than what is outstanding in the portfolio
- helps recue interest rate risk
(Bond Strategies)
Bullets
have very little payments during the interim period and then a lump sum at the some specified date in the future
- Most of the bonds will mature in or around the same time period
- Zero coupons, treasuries, and corporates are good candidates
- usually used when the investor has a balloon payment due on a liability at some future date
Preferred stock has both a
equity and debt feature
What is the difference between a preferred stock and a bond
- no maturity date like a bond
What is the difference between a preferred stock and a common stock
- Dividend does not fluctuate like a common stock
- price of preferred stock is more closely tied to interest rates than common stock
What are the tax advantages of a preferred stock
- Corporation receives a 50 or 65% deduction of dividends based on percentage of ownership of the company paying the dividends for tax years after 12/31/2017
What is the conversion value of a convertible bond
- is the value of the convertible bond in terms of the stock into which it can be converted
What is the primary benefit of a convertible bond
- even if the stock does not perform well the investor has a floor built in
- floor is the par value of the bond that the investor will receive if the convertible is held until maturity
What is the formula for conversion value of a convertible bond
CV = (PAR/CP) x Ps
- Ps = the price of the common stock
- CP = the conversion price
What is the property valuation formula
Capitalized Value = Net operating income/ Capitalization rate
Capitalization rate = NOI / Cost
How do you calculate Net operating income
Gross Rental Receipts
+ Non Rental Income
= Potential Gross Income
- Vacancy & Collection losses
= Effective gross income
- Total Expenses
= Net Income
+ Interest Expense
+ Depreciation Expense
= Net Operating Income
