chapter 6

Question 1

bond certificate

Answer 1

indicates the amounts and dates of all payments to be made. the terms of the bond are part of this. payments are made until the maturity date.

Question 2

maturity date

Answer 2

the final repayment date.

Question 3

term

Answer 3

the time remaining until the repayment date.

Question 4

coupons

Answer 4

the promised interest payments of a bond.

Question 5

principal/face value/nominal amount/par value

Answer 5

the notional amount we use to compute the interest payments. it is the amount of money that needs to be repaid at the end of the bond contract.

Question 6

coupon rate

Answer 6

determines the amount of each coupon payment. it is the interest percentage of the nominal value that will be paid each period. it is set by the issuer and stated in the bond certificate. it is expressed as an APR.

Question 7

zero-coupon bond

Answer 7

the simplest type of bond. it does not make coupon payments. the only cash payment the investor receives is the face value of the bond on the maturity date.

Question 8

treasury bills

Answer 8

government bonds with a maturity of up to one year. they are zero-coupon bonds.

Question 9

discount

Answer 9

a price lower than the face value.

Question 10

pure discount bonds

Answer 10

zero-coupon bonds that are traded at a discount.

Question 11

yield to maturity (YTM)

Answer 11

the discount rate that sets the present value of the promised bond payments equal to the current market price of the bond. the IRR of an investment in a bond is the YTM. it is the promised return of a bond. it is the annual interest rate (total return) earned by an investors who buys the bond today at the market price, assuming that the bond is held until maturity, and that all coupon and principal payments are made as promised.

Question 12

spot interest rates

Answer 12

refers to default-free, zero-coupon yields.

Question 13

zero-coupon yield curve

Answer 13

refers to the yield curve.

Question 14

coupon bonds

Answer 14

pay investors their face value at maturity. in addition, these bonds make regular coupon interest payments.

Question 15

treasury notes

Answer 15

have original maturities from one to ten years.

Question 16

treasury bonds

Answer 16

have original maturities of more than ten years.

Question 17

premium

Answer 17

a price greater than the face value of a coupon bond.

Question 18

par

Answer 18

a price equal to the face value of a coupon bond.

Question 19

duration

Answer 19

measures the sensitivity of a bond’s price to changes in interest rates. bonds with higher durations are highly sensitive to interest rate changes.

Question 20

coupon-paying yield curve

Answer 20

the plot of the yields of coupon bonds of different maturities.

Question 21

on-the-run bonds

Answer 21

the most recently issued bonds.

Question 22

corporate bonds

Answer 22

bonds issued by a corporation. the issuer may default, which means that they might not pay back the full amount promised in the bond prospectus.

Question 23

credit risk

Answer 23

the risk of default, meaning that the bond’s cash flows are not known with certainty.

Question 24

investment-grade bonds

Answer 24

bonds in the top four categories of creditworthiness. they have a low default risk.

Question 25

prospective bonds, junk bonds, or high-yield bonds

Answer 25

bonds in the bottom five categories of creditworthiness. they have a high likelihood of default.

Question 26

default spread/credit spread

Answer 26

the difference between the yields of corporate bonds and treasury yields. they fluctuate as perceptions regarding the probability of default change. it is high for bonds with low ratings and thus a greater likelihood of default.

Question 27

sovereign bonds

Answer 27

bonds issued by national governments. US treasuries are generally considered to be default free. this is not true for most sovereign debt. therefore, bonds with high probabilities of default have high yields and low prices.

Question 28

bond

Answer 28

a debt contract connected to a loan. it can be issued by firms or governments to raise money. they promise to make fixed payments in the future. they are tradeable securities.

Question 29

tradeable securities

Answer 29

securities that can be bought or sold after the initial acquisition by the investor.

Question 30

external capital

Answer 30

when firms raise money by issuing equity. those shares do not promise fixed cash flows in the future and therefore work differently than bonds.

Question 31

bond issuer

Answer 31

the firm or government that receives the money when the bond is issued.

Question 32

bond holder

Answer 32

invests the money in return for future coupon payments and a final repayment at the end of the bond contract. this may be risky because the bond issuer can default on the bond.

Question 33

semi-annual

Answer 33

means that there are payments every 6 months.

Question 34

price of the bond

Answer 34

the present value of all the cash flows.

Question 35

arbitrage free/no-arbitrage price

Answer 35

means that bonds with the same cash flows should have the same price.

Question 36

default-free securities

Answer 36

securities where you are sure to get paid.