chapter 6: bond valuation and interest rates part 3

Question 1

what is the yield to call (YTC/kc)

Answer 1

if a bond has a call feature, the issuer can call (or force the investor to sell the bond back to them) before the maturity stated on the bond indenture

Question 2

how long are called bonds initially protected from a call

Answer 2

for a period of a few years
ex 5,7, or 10
after which the issuer may call the bond

Question 3

how do you calculate the YTC yield to call

Answer 3

1. replace the maturity date with the first call date
2. the face value with the call premium (CP)
3. and the time to maturity (n) with the number of periods until expected call (c)

Question 4

what is the calculator method to calculate the YTC

Answer 4

(2nd) (CLRTVM) 30 (PMT) -1030(PV) 1050 (FV) 10 (N) (CPT) (I/Y) -

then multiply by 2 to annualize

Question 5

wat is the current yield

Answer 5

a bond’s current yield (CY) is the yield on the bond’s current market price provide by the annual coupon

Question 6

what does the current yield not consider

Answer 6

potential capital gains or losses

– it snot a true measure of return to the bondholder

Question 7

what is interest

Answer 7

it is the “price” of borrowed money

Question 8

how is interest measured in

Answer 8

basis points or

1/100th of 1% (eg. 250 basis points is 2.5%)

Question 9

when do interest rates rise

Answer 9

when the demand for loanable funds rise

Question 10

when do interest rates fall

Answer 10

when the demand for loanable funds fall

Question 11

what is the risk-free interest rate

Answer 11

it is an abstract concept,

usually the yield on short-term government treasury bills is used as a proxy for practical purposes

Question 12

what is the risk-free interest rate comprised of

Answer 12

two components

1. the real rate
2. expected inflation rate

Question 13

what is the real rate

Answer 13

compensation for deferring consumption

Question 14

what is the expected inflation rate

Answer 14

compensation for the expected loss of purchasing power over the term of the short-term T-bill

Question 15

What are Canadian interest rates heavily influenced by

Answer 15

change in interest rates in other countries

macroeconomic factors (bot domestic and global play an important role )

Question 16

what is the interest rate parity theory (IRP)

Answer 16

states that foreign exchange forward rates will be established tat equalize the yield an investor can earn
- whether investing domestically or in a foreign jurisdiction

Question 17

a country with both high inflation and high interest rates will have what

Answer 17

a depreciation currency

Question 18

what is the term structure of interest rates

Answer 18

the set of rates (YTM) for all maturities of a given risk-class of debt securities at a given point in time

Question 19

what are the 3 typical yield curves

Answer 19

1. upward sloping or normal (1994)
2. downward sloping or inverted (1990)
3. flat (1998)

• for gov. of Canada bonds