Chapter 4

Question 1

Present Value

Answer 1

based on notion that a dollar paid to you one year from now is less valuable to you than a dollar paid to you today

Question 2

Present value (PV)

Answer 2

is the current value of a future sum of money or stream of cash flow given a specified rate of return

Question 3

Fixed Payment Loan

Answer 3

Multiple fixed payments at pre-specified dates

Question 3

Net present value (NPV)

Answer 3

is the difference between the present value of cash inflows and the present value of cash outflows over a period of time

Question 3

Simple Loan

Answer 3

One payment at the maturity date

Question 4

Coupon Bond

Answer 4

A bond that pays fixed amounts (the coupons) at fixed dates, plus a final payment (the face value) at maturity

Question 5

Discount Bond

Answer 5

A bond that pays zero coupons, only a final payment at maturity. “Discount” since price typically less than face value
-> so the bond is equal to the rate of capital gain

Question 6

The Price of Coupon Bond

Answer 6

Equals to the sum of the present values of all likely coupon payments plus the present value of the par value at maturity
It is the current market price for the coupon bond

Question 7

Consol

Answer 7

A coupon bond with no maturity

Question 8

If interest rates decline, would you rather be holding long-term bonds or short term-bonds

Answer 8

You would rather be holding long-term bonds because their price will increase more than the price of the short-term bonds, giving them a higher return

Longer-term bonds are more susceptible to higher price fluctuations than shorter-term bonds and have greater interest-rate risk

Question 9

The current yield is a good approximation to the yield to maturity when

Answer 9

• the maturity of the bond occurs over a ten-year period
• the bond price is very close to par

Question 10

Relationships between years to maturity, yield to maturity, and the current price

Answer 10

1. Whenever yield to maturity equals the annual coupon rate, the bond’s price is equal to its face value
2. Price and yield to maturity are negatively related
3. When yield to maturity is less than the annual coupon rate, price and years to maturity are positively related

Question 11

Real Interest Rate

Answer 11

Nominal Interest Rate - Inflation

Question 12

Yield to Maturity

Answer 12

The interest rate that equates the present value of cash flow payments received from a debt instrument with its value today