Chapter 6 - Bond Valuation

Question 1

bonds def

Answer 1

securities that obligate the issuer to make specified payments to the bond holder

Question 2

bond’s coupon def

Answer 2

the interest payment paid to the bondholder

Question 3

bond’s face value def

Answer 3

payment at the maturity of the bond (also called par value or maturity value)

Question 4

maturity of the bond def

Answer 4

the date on which the loan will be paid off is the maturity date

Question 5

coupon rate def

Answer 5

annual interest payment as a percentage of the face value.
In other words , it is the annual interest payment divided by the face value of the bond

Question 6

interest rate (or discount rate or yield) def

Answer 6

the rate at which the cash flows from the bond are discounted to determine its present value

Question 7

Bond present value

Answer 7

The price of a bond is the present value of all its future cash flows : PV of coupon payments + PV face value

Question 8

when does a bond sell for its face value? (at par)

Answer 8

when the interest rate is the same as the coupon rate

Question 9

when does a bond sell less than face value ? (at a discount)

Answer 9

when market interest rate > coupon rate

Question 10

when does a bond sell for higher than face value ? ( at a premium)

Answer 10

when the market interest rate < coupon rate

Question 11

semi- annual coupon payments def

Answer 11

• semi-annual coupon payments implies that the annual coupon payment is paid in two equal installments, every six months
• need to compute six month required return

Question 12

current yield def

Answer 12

annual coupon payment / current bond price

Question 13

yield to maturity def

Answer 13

interest rate for which the present value of the bond’s payments equals the price

essentially the rate of return when you keep a bond until maturity

Question 14

rate of return def

Answer 14

total income per period per dollar invested

Question 15

interest rate risk def

Answer 15

the risk in bond prices due to fluctuations in interests rates

Question 16

interest rates changes and how it affects bonds

Answer 16

• the longer the maturity the higher the interest rake risk
• the lower the coupon bond rate the higher the interest rate risk

Question 17

default risk (or credit risk) def

Answer 17

the risk that a bond issuer may default on its bonds

Question 18

Bonds and their default risk rating

Answer 18

BBB and up : investement grade bond (not very risky)
BB and below : speculative grade, high yield, junk bonds (very risky)

Question 19

default premium def

Answer 19

the difference between the promised yield on a corporate bond and the yield on a canada bond with the same coupon and maturity

Question 20

capital gains yield formula

Answer 20

(P1 - P0)/ P0

look at rate of return second part of the formula