Chapter 2&10 (Bonds)

Question 1

Bankers’ Acceptance

Answer 1

An order to a bank by a customer to pay a sum of money at a future date.

Question 2

Call Option

Answer 2

The right to buy an asset at a specified exercise price on or before a specified expiration date.

Question 3

Certificate of Deposit

Answer 3

A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.

Question 4

Commercial Paper

Answer 4

Short-term unsecured debt issued by large corporations.

Question 5

Common Stocks

Answer 5

Ownership shares in a publicly held corporation. Shareholders have voting rights and may receive dividends.

Question 6

Corporate Bonds

Answer 6

Long-term debt issued by private corporations typically paying semiannual coupons and returning the face value of the bond at maturity.

Question 7

Derivative Asset

Answer 7

A security with a payoff that depends on the prices of other securities.

Question 8

Equally Weighted Index

Answer 8

An index computed from a simple average of returns.

Question 9

Eurodollars

Answer 9

Dollar-denominated deposits at foreign banks or foreign branches of American banks.

Question 10

Federal Funds

Answer 10

Funds in the accounts of commercial banks at the Federal Reserve Bank.

Question 11

Futures Contract

Answer 11

Obliges traders to purchase or sell an asset at an agreed-upon price at a specified future date.

Question 12

London Interbank Offer Rate (LIBOR)

Answer 12

Lending rate among banks in the London market.

Question 13

Market Value-Weighted Index

Answer 13

Index return equals the weighted average of the returns of each component security, with weights proportional to outstanding market value.

Question 14

Money Markets

Answer 14

Include short-term, highly liquid, and relatively low-risk debt instruments.

Question 15

Municipal Bonds

Answer 15

Tax-exempt bonds issued by state and local governments.

Question 16

Preferred Stock

Answer 16

Nonvoting shares in a corporation, usually paying a fixed stream of dividends.

Question 17

Price-Weighted Average

Answer 17

An average computed by adding the prices of the stocks and dividing by a “divisor.”

Question 18

Put Option

Answer 18

The right to sell an asset at a specified exercise price on or before a specified expiration date.

Question 19

Repurchase Agreements (Repos)

Answer 19

Short-term sales of government securities with an agreement to repurchase the securities at a higher price.

Question 20

Treasury Bills

Answer 20

Short-term government securities issued at a discount from face value and returning the face amount at maturity.

Question 21

Treasury Notes or Bonds

Answer 21

Debt obligations of the federal government with original maturities of one year or more.

Question 22

What determines the price of a bond?

Answer 22

Present value of the promised payments

Question 23

What characterizes a bonds yield to maturity? 2

Answer 23

• discount rate

- average rate of return

Question 24

A junk bond is characterized based on …

Answer 24

Credit Rating

Question 25

when will a firm call its bonds?

Answer 25

When interest rates fall

Question 26

What should a zero coupon bond experience over its life?

Answer 26

Appreciation.

Question 27

Bond Characteristics. 2

Answer 27

- Fixed income investments - Security that obligates issuer to make fixed payments to holders over time - periodical interest usually paid semiannually

Question 28

Benefits of a bond in a Portfolio. 6

Answer 28

- Diversification - Weak correlation with stock. - lower stand. Dev. than equities/ fewer losses. - Dividend Clientele - Higher return than CD's or Savings Accounts. - Some have Tax Advantages

Question 29

Face (Par) Value

Answer 29

Principle of Bond

Question 30

Coupon Payment

Answer 30

Interest Payment

Question 31

Coupon Rate

Answer 31

interest payment per dollar of par value

Question 32

Maturity

Answer 32

When you receive the principle

Question 33

Price of Bond

Answer 33

- How much you pay fo da bond | - present value of coupon payments and principles

Question 34

Yield to Maturity

Answer 34

- Actual Return | - the discount rate

Question 35

Credit Rating

Answer 35

the default risk of a bond

Question 36

How does a rise in market interest rate effect bond prices?

Answer 36

Prices of Bonds fall, opposite correlation to market interest rate

Question 37

What is the primary source of bond market risk?

Answer 37

Interest Rate Fluctuations

Question 38

Par Bond

Answer 38

when price= face valueor coupon rate = yield to maturity

Question 39

Premium Bond

Answer 39

when price> face valueor coupon rate> face value

Question 40

Discount Bond

Answer 40

when price< face value or coupon rate< face value

Question 41

Who establishes Credit Ratings?

Answer 41

Moody's, S&P, Fitch

Question 42

What classifies as an investment grade bond?

Answer 42

S&P- BBB or aboveMoody's - Baa or above

Question 43

What classifies as a junk bond

Answer 43

S&P - BB or lowerMoody's - Ba or lower OR unrated :)

Question 44

Corporate bonds

Answer 44

- issued by corporations - call feature: allows issuer to redeem bond prior to maturity - convertible feature: holders have the option of converting to stock

Question 45

Municipal Bonds

Answer 45

-issued by municipalities - nontaxable at the federal, state, & local level if you live in the state.

Question 46

Risk of Bonds. 5

Answer 46

- credit risk - interest rate risk - exchange rate risk (if foreign bonds) - inflation risk - call risk (firm will buy back bond)

Question 47

Types of Bonds. 3

Answer 47

- treasury bonds - corporate bonds - municipal bonds

Question 48

What is invoice price

Answer 48

Flat price + Accrued interest

Question 49

Expectations Hypothesis

Answer 49

yields to maturity determined solely by expectations of future short-term interest rates or inflation rate

Question 50

Liquidity Hypothesis

Answer 50

Investors demand a risk premium on long-term bonds

Question 51

Interest rate sensitivity

Answer 51

- Bond prices and yields are inversely related - Long-term bond prices more sensitive to interest rate changes than short-term bonds - as maturity increases, sensitivity of bond prices to changes in yields increases at decreasing rate - low coupon bonds are more sensitive to interest rates

Question 52

What is duration?

Answer 52

How sensitive bonds are to interest risk

Question 53

Zero coupon bond

Answer 53

duration=time to maturity

Question 54

Immunization

Answer 54

-Strategy to shield net worth from interest rate movement -two of setting interest rate risk; price risk and reinvestment rate-match the duration with the investment horizon

Question 55

Bond Swaps

Answer 55

- managing bond portfolio by selling some bonds and buying others - benefits include tax treatment (loss now gains later), yield, and maturity structure

Question 56

Bullets

Answer 56

Mainly use zero-coupon bond-cash flow matching-generate cash outflow in a certain date

Question 57

Barbells

Answer 57

-owning both short and long-term bond

Question 58

Laddered Strategy

Answer 58

- Cash management: relatively liquid | - reduce interest risk (hold bonds until maturity)

Question 59

Convexity

Answer 59

-curvature of price yield relationship of bond

Question 60

How are Stocks Weighted? 3

Answer 60

- Price Weighted (DJIA) - Market Value Weighted (S&P 500, NASDAQ) - Equally Weighted

Question 61

Value Weighting Implications. 2

Answer 61

- larger stocks dominate index | - Performance characteristics reflect size

Question 62

Equal/Price Weighting Implications. 3

Answer 62

- Smaller Stocks are more important - Tend to be more volatile, Higher Beta - Higher expected return