Chapter 10: Bonds and Yields

Question 1

What is a bond?

Answer 1

A security that obligates the issuer to make specified payments to the holder over a period of time.

Question 2

What is par value/face value?

Answer 2

The payment to the bond-holder at the maturity of the bond.

Question 3

What is the coupon rate?

Answer 3

A bond’s annual interest payment per dollar of par value.

Question 4

What is a zero-coupon bond?

Answer 4

A bond paying no coupons that sells at a discount and provides only a payment of par value at maturity.

Question 5

What is the formula for accrued interest?

Answer 5

Accrued interest =
(annual coupon payment/2) x
(days since last coupon payment/days separating coupon payment)

Question 6

What is a callable bond?

Answer 6

Bonds that may be repurchased by the issuer at a specified call price during the call period?

Question 7

What is a convertible bond?

Answer 7

A bond with an option allowing the bondholder to exchange the bond for a specified number of shares of common stock in the firm.

Question 8

What is a put bond?

Answer 8

A bond that the holder may choose either to exchange for par value at some date of to extend for a given number of years.

Question 9

What is a floating-rate bond?

Answer 9

Bonds with coupon rates periodically reset according to a specified market rate.

Question 10

What is preferred stock?

Answer 10

Dividends owed simply cumulate, and effectively become a perpetuity.

Question 11

What are examples of innovative bonds?

Answer 11

• Inverse Floaters
• Asset-backed Bonds
• Pay-In Kind Bonds
• Catastrophe Bonds
• Indexed Bonds

Question 12

How is a security valued?

Answer 12

Bond value = PV of coupons + PV of par value

Price = coupon (1/r)[1-(1/(1+r)ᵗ] + Par value x (1/(1+r)ᵗ)

Question 13

What is yield to maturity?

Answer 13

The discount rate that makes the PV of a bond’s payments that are equal to its price.

Question 14

What is realised compound return?

Answer 14

Compound rate of return on a bond with all coupons reinvested until maturity.

Question 15

How is the compound rate of return calculated?

Answer 15

V₀(1+r)²=V₂

Question 16

What is horizon analysis?

Answer 16

Analysis of bond returns over a multiyear horizon, based on forecasts of the bond’s yield to maturity and the reinvestment rates of coupons.

Question 17

What is the yield curve?

Answer 17

A graph of yield to maturity as a function of term to maturity.

Question 18

What is the term structure of interest rates?

Answer 18

The relationship between yields to maturity and terms to maturity across bonds.

Question 19

What is expectations hypothesis?

Answer 19

The theory that yields to maturity are determined solely by expectations of future short-term interest rates.

Question 20

What is the forward rate?

Answer 20

The interred short-term rate of interest for a future period that makes the expected total return of a long-term bond equal to that of rolling over short-term bonds.

Question 21

What is liquidity preference theory?

Answer 21

The theory that investors demand a risk premium on long-term bonds.

Question 22

What is a liquidity premium?

Answer 22

The yield spread demanded by investors as compensation for the greater risk of longer-term bonds.