Chapter 8: Bonds

Question 1

Types of Bonds

Question 2

Under corporate bonds we have:

Answer 2

• vanilla bonds
• zero coupon bonds
• convertible bonds

Question 3

What is the relationship of bonds and interest rates

Answer 3

?

Question 4

where do bonds trade

Answer 4

?

Question 5

coupon payments (concept)

Answer 5

• the interest payments made to bondholders
• (These payments are usually made annually or semiannually)
• (and the payment amount (or rate) remains fixed for the life of the bond contract, which for our example is three years)

Question 6

coupon rate

Answer 6

• is the annual coupon payment (C) divided by the bond’s face value (F).

Question 7

Par value (or face value)

Answer 7

• the amount on which interest is calculated and that is owed to the bondholder when a bond reaches maturity

Question 8

par value bonds

Answer 8

• whenever a bonds coupon rate is equal to the market rate of interest on similar bonds, the bond will set at par (face) value

Question 9

discount bonds

Answer 9

bonds that sell at prices below par (face) value

Question 10

premium bonds

Answer 10

• bonds that sell at prices above par (face) value

(Whenever a bond’s coupon rate is higher than the market rate of interest, the bond will sell at a premium)

Question 11

compounding

Answer 11

?

Question 12

bond pricing summarized

Answer 12

Our discussion of bond pricing can be summarized as follows, where i is the market rate of interest:

i > coupon rate—the bond sells for a discount
i < coupon rate—the bond sells for a premium
i = coupon rate—the bond sells at par value

Question 13

bond valuation- how to compute

Answer 13

?

Question 14

yield to maturity

Answer 14

• for a bond, is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond
• (The yield to maturity can be viewed as a promised yield because it is the annual return that the investor earns if the bond is held to maturity and all the coupon and principal payments are made as promised)
• (A bond’s yield to maturity changes daily as interest rates increase or decrease, but its calculation is always based on the issuer’s promise to make interest and principal payments as stipulated in the bond contract)

Question 15

risks for bonds

Answer 15

?

Question 16

interest rate risk

Answer 16

uncertainty about future bonds values that is caused by the unpredictability of interest rates

Question 17

call provision concept

Answer 17

• a call provision gives the firm issuing the bonds the option to purchase the bond from an investor at a predetermined price (the call price)
• The investor must sell the bond at that price to the firm when the firm exercises this option
• Bonds with a call provision pay higher yields than comparable noncallable bonds
• Investors require the higher yields because call provisions work to the benefit of the borrower and the detriment of the investor.

Question 18

how to calculate a bond price with a call?

Question 19

why are bond ratings important

Answer 19

?

Question 20

yield to call

Answer 20

the replacement of yield to maturity

Question 21

Noncallable bonds

Answer 21

“runs to maturity”

Question 22

callable bond

Answer 22

gives them the option to call the bond and when the call it is when they mature it. Your yield to maturity becomes your yield to call

Question 23

bonds

Answer 23

legally required to pay coupons

Question 24

stocks

Answer 24

choice in paying dividends (firm not require to pay dividends)