Chapter 7 Flashcards
What is the most accurate method used to determine the value of bond?
Present value (sum of money on a specific date in the future).
What are the step to calculate PV?
- Appropriate i
- PV from coupon
- PV principal
- Sum up.
What is the discount rate (i)?
is the rate at which the future value is discount to present value
What factor affect the discount rate i?
- risk
- yields currently applicable to bonds with similar coupon, term and credit quality
- Market condition
- often = risk free rate + spread
What is the formula to calculate the yield on T-bill?
Yield = (100 - p ) / p * 365/term * 100
What is current yield on a bond?
Current yield looks only at cash flows and the current market price of an investment, not at the amount that was invested.
How to calculate the current yield on a bond?
Current yield = annual cash flow /current market price * 100%
What is yield to maturity (YTM)?
is the total return you would expect to earn over the life of a bond starting today, assuming you are able to reinvest each coupon payment at the same YTM.
How to approximate calculate YTM?
AYTM = (interest income +- price change per compounding period)/((purchase price + par)/2) * 100%
Price change per compounding period = (par - price)/N
In which case Current yield = YTM = AYTM?
when price = par value
What is reinvestment risk?
is the risk that the coupons will earn a return at a lower overall rate than the rate at the time the bond was purchased
What does “YTM at the time of purchase would be understated” mean?
when coupon payments are reinvested at the rate higher than the bond’s YTM at the time of purchase.
What does “YTM at the time of purchase would be overstated” mean?
when coupon payments are reinvested at the rate lower than the bond’s YTM at the time of purchase.
Which bond has no reinvestment risk?
Zero coupon bond.
What is Fisher theory?
Nominal rate = real rate + inflation rate
What is yield curve?
Relationship between long-term and short-term yields.
-> base on real number -> with same credit quality, the longer the term, the higher the yield.
What are the theories that attempt to explain the shape of the yield curve?
Expectations theory, liquidity preference theory and market segmentation theory.
What is expectations theory about?
long-term interest rates foreshadow future short-term rate -> investors buying a single long-term bond should expect to earn the same amount of interest as they would buying 2 short-term bonds of equal combined duration -> the shape of the yield curve indicates investor expectations about the future interest rates.
What is the formula to calculate rate in expectation theory?
(1 + r2y) binh phuong = (1 + ry1) (1+ ry2)
What is liquidity preference theory about?
investors prefer short-term bonds because they are more liquid and less volatile in price -> need compensation to buy long-term bonds.
What is market segmentation theory about?
yield curve represents the supply of and demand for bonds of various terms.
How many types of yield curve?
- normal upward-sloping curve
- Inverted (downward sloping)
- humped curve (up and down)
What is the relationship between bond yields and interest rate?
are often used interchangeably and both mean a rate of return on an investment -> interest rate rise, bon yields also rise. (because the coupon rate doesn’t change -> price will have to change so that bond yield can keep up with interest rate)
What is the relationship between interest rate and bond price?
Interest rate rise, bond price fall
What is the difference between longer-term bonds and shorter-term bond?
Longer-term bond are more volatile in price than shorter-term bonds.
what is the relationship between lower-coupon bonds and high-coupon bonds?
Lower-coupon bonds are more volatile in price percentage change than high-coupon bonds