Bond Valuation (Lesson 6) Flashcards
1
Q
What is the coupon rate of a bond
A
- the periodic interest payment received by a bond holder
2
Q
What is the par value of a bond
A
- 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
3
Q
What is the length of time to maturity of a bond
A
- the time remaining until the bond holder receives the par value
- Number of periods to maturity or that the loan will be outstanding
4
Q
What is the market interest rate of a bond
A
- 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
5
Q
Do changes in interest rates in the marketplace affect the coupon payment
A
No
6
Q
Rising interest rates in the marketplace means than old issued bonds will sell at a
A
discount
7
Q
Falling interest rates in the marketplace means that old issued bonds will sell at a
A
premium
8
Q
How do you calculate the coupon rate of the bond
A
- Coupon rate = Coupon payment / Par
9
Q
How do you calculate the current yield of a bond
A
- Current yield = Coupon payment / Price of bond
10
Q
What is the yield to maturity of a bond
A
- 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
11
Q
What is the yield to call of a bond
A
- the compounded rate of return if an investor buys a bond today and the bond is called by the issuer
12
Q
Bonds selling at a discount put the below in order from smallest to largest
Yield to Maturity
Current Yield
Yield to Call
Nominal Yield
A
- Nominal yield
- Current yield
- Yield to Maturity
- Yield to Call
13
Q
Bonds selling at a Premium put the below in order smallest to largest
Yield to Maturity
Current Yield
Yield to Call
Nominal Yield
A
- Yield to call
- Yield to maturity
- Current yield
- Nominal yield
14
Q
Does the coupon rate change whether a bond sells at a premium or discount
A
- No stays consistent
15
Q
What is accrued interest
A
- 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
16
Q
What type of account should treasury zero coupon bonds be held in
A
- IRA because the bond pays phantom income
- The IRA will not require the recognition of the phantom income
17
Q
(Yield Curve Theories)
Liquidity Preference Theory
A
- 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
18
Q
(Yield Curve Theories)
Market Segmentation Theory
A
- 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)
19
Q
(Yield Curve Theories)
Expectations Theory
A
- 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
20
Q
What is the unbiased expectations theory
A
- 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
21
Q
What is duration
A
- 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
22
Q
What is the duration of a zero coupon bond
A
- duration equals its maturity
23
Q
As the coupon rate increases the duration
A
- decreases
24
Q
As yield to maturity increases the duration
A
- decreases
25
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
26
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
27
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)
28
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
29
Does duration understate or overstate the price appreciation when interest rates decrease
- understates
30
Does duration understate or overstate the price appreciation when interest rates increase
- overstates
31
(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
32
(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
33
(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
34
(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
35
Preferred stock has both a
equity and debt feature
36
What is the difference between a preferred stock and a bond
- no maturity date like a bond
37
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
38
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
39
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
40
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
41
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
42
What is the property valuation formula
Capitalized Value = Net operating income/ Capitalization rate
Capitalization rate = NOI / Cost
43
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
