Chapter 10

Question 1

What are the different ways in which we can compare cash payments (cash flow) of different amounts and with different timing?

Answer 1

With the use of present value, which is the measurement of the value of money in the present

Question 2

What is the equation for Present Value?

Answer 2

CF/(1+i)^n

Question 3

What are the four types of credit market instruments?

Answer 3

Simple Loan
Fixed Payment Loan
Coupon Bond
Discount Bond

Question 4

What is yield to maturity?

Answer 4

It is the most important way to calculate interest rates.
It is the interest rate that equates the present values of all cash flow payments received from a debt instrument with its value today

Question 5

What are the three facts about coupon bonds that characterize it?

Answer 5

1. When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate
2. The price of a coupon bond and the yield to maturity are negatively related
3. The yield to maturity is greater than the coupon rate when the bond price is below its face value

Question 6

What is consol or perpetuity?

Answer 6

It is a bond with no maturity date that does not repay principal but pays fixed coupon payments forever

Question 7

What is the equation for Consol or Perpetuity?

Answer 7

ic = C/Pc
Pc = price of the consol
C = yearly interest payment
ic = yield to maturity of the consol

Question 8

What is the equation for discount bond?

Answer 8

i = F-P/P
F = face value of the discount bond
P = current price of the discount bond

Question 9

What is the rate of return?

Answer 9

It is how well a person does financially by holding a bond for some period of time

Question 10

What does return depend on?

Answer 10

It depends on the coupons received and the price for which the bond is eventually sold

Question 11

When does the return equal to the yield to maturity?

Answer 11

When the holding period equals to the time to maturity

Question 12

What does a rise in interest rates that is associated with a fall in bond prices result in?

Answer 12

It results in a capital loss of time to maturity that is longer than the holding period

Question 13

What occurs when a bond is more and more distant to maturity?

Answer 13

It leads to a greater size of the percentage price change associated with an interest-rate change

Question 14

What occurs the more distant a bond’s maturity?

Answer 14

The lower the rate of return occurs as a result of an increase in the interest rate

Question 15

Can the return be negative if the interest rates rise even if a bond has a substantial initial interest rate?

Answer 15

Yes it can

Question 16

What is the risk level associated with an asset’s return that results from interest-rate change?

Answer 16

Its interest-rate risk

Prices and returns for long-term bonds are more volatile than those for shorter-term bonds
There is no interest-rate risk for any bond whose time to maturity matches the holding period

Question 17

What are nominal interest rates?

Answer 17

They are interest rates that make no allowance for inflation

Question 18

What are real interest rates?

Answer 18

They are rates that adjust for changes in price level

Question 19

What is the Fisher Effect equation?

Answer 19

1 + rn = (1+rr) x (1 + i)

Question 20

What does the fisher equation describe?

Answer 20

When the real interest rate is low, there are greater incentives to borrow
Low interest rates reduces the incentives to lend
The real interest rate is a better indicator of the incentives to borrow or lend