Chapter 4 Bonds & Valuation

Question 1

What is the par value of a bond?

Answer 1

The par value is the stated face value of the bond, it is the amount that the firm borrows and promises to return on the maturity date.

Question 2

What is the coupon interest rate?

Answer 2

The coupon interest rate is the specified interest earned on the bond’s par value that will be given to investors on a periodic basis.

Question 3

What is a call provision?

Answer 3

Call provisions gives the issuer the right to call the bonds for redemption. These provisions state that the issuer must pay the bondholders an amount greater than the par value if they are called.

Question 4

What are sinking funds?

Answer 4

A provision in a bond contract that requires the issuer to buyback/retire a certain amount of bonds issued each year. There are generally two ways this is done

1) A random raffle
2) Open market transactions.

Question 5

What are the fixed aspects in a bond

Answer 5

1. Maturity Date
2. Coupon Interest Rate
3. Payment Frequency
4. PAR Value

Question 6

What aspects of a bond can be changed

Answer 6

1. Yield to Maturity

2. Price of Bond

Question 7

How do you determine what is a premium bonds

Answer 7

Premium bonds sell at a price higher than their par value. They are compensated by having a higher coupon rate as compared to yield to maturity. This higher coupon rate pays them higher coupons to mitigate the difference between par value and paying price.

Question 8

How do you determine what is a discount bond

Answer 8

Discount bonds are sold below par value with higher yield to maturity rates but lower coupon rates. The higher ytm compensates the investors for the low coupon rates.

Question 9

What happens to the value of a bond when interest rates go up?

What happens if interest rates go down?

Answer 9

Because the value of a bond is dependent on interest rates as the denominator, if interest rate increases, the present value of a bond decreases. Similarly, if interest rate decreases, the present value of the bond increases

Question 10

List the relationships between coupon interest rate, yield to maturity and the type of bonds

Answer 10

if coupon rate > yield to maturity / required returns. The bond is a premium bond

If coupon rate < Yield to maturity / required returns. The bond is a discount bond

If coupon rate = Yield to maturity / required returns. The bond is a par bond.