chapter 6: bond valuation and interest rates part 2

Question 1

are interest rates inversely related to bond prices?

Answer 1

yes

Question 2

when bond prices increase what happens to interest rates?

Answer 2

interest rates decrease

Question 3

when bond prices decrease what happens to interest rates?

Answer 3

interest rates increase

Question 4

what are the factors affecting bond prices

Answer 4

the relationship between the coupon rate and bond’s yield to maturity (YTM) determines if a bond will sell at a

1. premium
2. discount or
3. at par

Question 5

if the coupon rate is greater than YTM

Answer 5

the price will be greater than face value

= discount

Question 6

if the coupon rate = YTM

Answer 6

price will = Face value

at par

Question 7

if the coupon rate is less than YTM

Answer 7

price is less than face value

premium

Question 8

what are the factors affecting bond prices

Answer 8

1 . YTM

2. time to maturity
3. size of coupon
4. interest rate risk and duration
   - –

Question 9

what affects to volatility of a bond

Answer 9

time to maturity and size of the coupon

Question 10

when bond prices increase what happens to YTM

Answer 10

YTM decreases

Question 11

when bond prices decrease what happens to YTM

Answer 11

YTM increases

Question 12

what is the price-YTM relationship

Answer 12

it is convex

Question 13

because the price -YTM relationship is convex, the price ….

Answer 13

rise due to a fall in YTM is greater than the price decline due to a rise in YTM given an identical change in YTM

Question 14

for a given change in YTM, bond prices will change more when

Answer 14

interest rates are low than when they are high

Question 15

what is volatility

Answer 15

Volatility is the pace at which prices move higher or lower,

Commonly, the higher the volatility, the riskier the security.

Question 16

when speaking about time to maturity, which maturity bonds have a greater price volatility (long-maturity or short maturity)

Answer 16

long-maturity bonds

the longer the bond, the longer the period for which the cash flows are fixed

Question 17

how does the size of the coupon affect the bond prices

Answer 17

low coupon bonds - have greater price volatility than higher coupon bonds

Question 18

why are high coupon bonds les volatile than low coupon bonds

Answer 18

because they act like a stabilizing device
- since a greater proportion of the bond’s total cash flows occur closer to today and are therefore their present value is less affected by a change in YTM

Question 19

the sensitivity of a bond’s price to change in interest rates is a measure of what

Answer 19

of the bond’s interest rate risk

Question 20

interest rate risk is affected by what

Answer 20

1. YTM
2. term to maturity
3. size of coupon

Question 21

duration measure of interest rate risk

Answer 21

1. as a change in price for a given change in interest rate

2. the higher the bond’s duration, the more sensitive its price is to changes in interest rates

Question 22

a bond’s duration will be higher if its …….

Answer 22

YTM is lower
term to maturity is longer
coupon is lower

Question 23

what is the quoted price

Answer 23

the price reported by the media

Question 24

what is the cash price

Answer 24

the price paid by an investor, and includes both

1. the quoted price plus any interest that has accrued since the last coupon payment date

Question 25

what is the YTM

Answer 25

it is the discount rate used for bond valuation

Question 26

YTM is the yield an investor would earn if

Answer 26

1. she purchases the bond at the current market price
2. she holds the bond to maturity
3. she reinvests all the coupons paid by the bond at the YTM

Question 27

what is IRR

Answer 27

internal rate of return which is the YTM

Question 28

ytm is therefore the bond’s

Answer 28

internal rate of return IRR

Question 29

YTm is also the

Answer 29

discount rate that causes the PV of the bond’s future cash flows to equal its current price

Question 30

how do you solve YTM

Answer 30

(2nd) (CLRTVM) 30 (PMT) - 1030 (PV) 1000 (FV) 40 (N) (CPT) (I/Y) =
then multiply by 2 to annualize

Question 31

why do you enter the price as a negative number

Answer 31

because it is a cash outflow to purchase the bond

Question 32

why do you enter the coupon and principal payments as positive numbers

Answer 32

these are cash inflows