CH6 Flashcards
What is a bond?
A long-term contract where a borrower pays interest and repays principal to lenders.
What is the face value of a bond?
The amount repaid to bondholders at maturity, usually $1,000.
What is a coupon payment?
The periodic interest payment made to bondholders.
What is a coupon rate?
The percentage of the face value paid as interest annually.
What is a maturity date?
The date when the bond’s face value is repaid.
What is a callable bond?
A bond that can be repurchased by the issuer before maturity.
What is a zero-coupon bond?
A bond that does not pay interest but is sold at a discount.
What is a sinking fund provision?
A method of repaying bonds gradually instead of a lump sum.
What is default risk?
The chance that the issuer fails to make payments.
What is a convertible bond?
A bond that can be converted into company stock.
What is the bond pricing formula?
P = ∑ (C / (1+r)^t) + (F / (1+r)^N)
How do you calculate the current yield of a bond?
CY = Coupon Payment / Market Price
What is the formula for yield to maturity (YTM)?
YTM = (C + (F - P) / N) / ((F + P) / 2)
What is the formula for capital gains yield (CGY)?
CGY = ΔP / P
How does market interest rate affect bond price?
Higher rates lower bond prices, lower rates increase bond prices.
What happens when a bond’s YTM is higher than its coupon rate?
The bond trades at a discount.
What happens when a bond’s YTM is lower than its coupon rate?
The bond trades at a premium.
How do you calculate bond price with semiannual payments?
Divide coupon rate by 2, number of periods by 2, and YTM by 2.
How do callable bonds affect investors?
They increase risk for investors as issuers can repurchase them early.
What is the real risk-free rate formula?
r* = rd - IP (Nominal rate minus inflation premium).
Why do callable bonds typically have higher yields?
Investors require compensation for call risk.
How does reinvestment risk impact investors?
If rates drop, future returns on reinvested payments are lower.
What is the risk of investing in long-term bonds?
Interest rate risk (price fluctuation due to changing rates).
What is the risk of investing in short-term bonds?
Reinvestment risk (having to reinvest at lower rates).
Why do zero-coupon bonds always sell at a discount?
They provide no interest payments, so value comes from the discount.
What happens to bond prices when inflation increases?
Prices drop because higher rates are needed to compensate for inflation.
When should you expect to earn YTC instead of YTM?
If interest rates drop, issuers will call bonds early to refinance.
Why do corporate bonds have higher yields than government bonds?
Corporate bonds have default risk, while government bonds are safer.
How does a sinking fund benefit bondholders?
It ensures gradual repayment, reducing default risk.
What factors determine the market interest rate on bonds?
Inflation, risk premiums, and economic conditions.
