chapter 7

Question 1

What is a bond?

Answer 1

A long-term debt instrument in which a
borrower agrees to make payments of
principal and interest, on specific dates, to
the holders of the bond.

Question 2

Bonds are issued by?

Answer 2

corporations and
government agencies that are looking for longterm debt capital.
– Corporate bonds, treasury bonds, municipal
bonds(munis), foreign bonds

Question 3

bond markets are?

Answer 3

Primarily traded in the over-the-counter (OTC)
market.
most bonds are not traded in the
secondary market via exchanges.
• Most bonds are owned by and traded among
large financial institutions.
• Each bond has different maturity, coupon,
nominal value, and credit rating

Question 4

what are the key features of a bond?

Answer 4

Par value: face amount of the bond, which
is paid at maturity (assume $1,000).
• Coupon interest rate: stated interest rate
(generally fixed) paid by the issuer. Multiply by
par value to get dollar payment of interest.
• Maturity date: years until the bond must be
repaid.
• Issue date: when the bond was issued.
• Yield to maturity: rate of return earned on
a bond held until maturity (also called the
“promised yield”).

Question 5

a call provision?

Answer 5

gives the issuer the right to call the bonds for redemption. generally states that the issuer must pay the bondholders an amount greater than the par value if they are called
(gives the issuer the right to call and recieve a amount greater than the par value when called)

Question 6

a call premium

Answer 6

the additional sum often equal to one years interest

Question 7

what are the effects of a call provision

Answer 7

1. Allows issuer to refund the bond issue if
   rates decline (helps the issuer, but hurts
   the investor).
2. Bond investors require higher yields on
   callable bonds.
3. In many cases, callable bonds include a
   deferred call provision and a declining call
   premium.

Question 8

whats a convertible bond vs. warrant?

Answer 8

CB: may be exchanged for common stock of the firm at a fixed price at the option of the bondholder
warrant: long term option to buy a stated number of shares of cs at a specified price

Question 9

putable bonds?

Answer 9

allows holder to sell the bond

back to the company prior to maturity

Question 10

indexed bond?

Answer 10

interest rate paid is based
upon the rate of inflation.
– nominal rate = real interest rate + inflation rate
– Protect bondholders against inflation

Question 11

What would happen to the value of these three
bonds if the required rate of return(yield to
maturity) remained at 10%?
coupon rates at
13
10
7

Answer 11

the present valuest at the highest the coupon rate is higher than the 7 no matter the years to maturity

Question 12

if the market rate of interest on the bond remains constant?

Answer 12

The value of a premium bond would decrease
over time, until it reached $1,000.
– The value of a discount bond would increase
over time, until it reached $1,000.
– The value of a par bond stays at $1,000.

maturity, the value of any bond must equal
its par value.

Question 13

whats the The bond’s yield (Yield to Maturity: YTM)

Answer 13

should give us an estimate of
the rate of return we would earn if we purchased the bond today and
held it over its remaining life

Question 14

if YTM > coupon rate

Answer 14

this bond sells at a discount

Question 15

if YTM

Answer 15

this bond sells at a premium

Question 16

what is the current yield(CY)

Answer 16

annual coupon payment / current price

Question 17

what is the Capital gains yield (CGY)

Answer 17

change in price / beginning price

Question 18

what is the Expected total return = YTM = ?

Answer 18

Expected CY + Expected CGY