Class 2

Question 1

The definition of a bond:

Answer 1

A debt instrument whereby an investor lends money to an entity (such as company or government) that borrows the funds for a defined period of time at a fixed (or variable) interest rate.

Question 2

Bonds terminology (4)

Answer 2

Repayment date: when money will be returned. Redemption or maturity date. Thre bond will be redeemed.

Interest Rate & Frequency: % paid as interest and how often it is paid. Also known as coupon on a bond

Nominal value: Face value, written on the face of the bond certificate.

Tradeable: Can be sold at any time, before they reach repayment date.

Question 3

Different terminolory on types of bonds: (5)

Answer 3

• Fixed-rate: Coupon payments do not vary
• Float-rate: Interest vary and change depending on the reference rate
• Zero coupon bond _ no coupon payment
• Perpetual bonds: bond where maturity is not set
• Inflation linked bonds: Deby secutiries with coupon payments derived form actual level of inflation

Zero coupon bond: the yield for the investor is the difference between face value and price of the bond.

Question 4

Yield vs Coupon

Answer 4

A yield is express as a % and is the return of the bond. How much is it worth now compared to a year before. And much money was made on %. (Annual percentage)

The coupon is the interest rate paid on the nominal value of the bond

Question 5

Price, Value and Yield to maturity

Answer 5

Price: Investors are willing to pau for the bond. Result of demand and supply in the market

Bond value: Theoretic price which consist of discounted payments form the bond. Present value of all payments associated with the bond.

Yield to maturity:
Overall interest earned by investors who buys a bond at the market price and hod it until maturity.

Question 6

Explain relationship between Interest rates and bond prices.

Answer 6

Interest rates increase, bond prices will decrease.

IR = 5% and Coupon = 5%. If IR increase to 10%. Coupon rate 5% no longer attractive, so the price of the bond itself will decrease to compensate to make the offer more competitive.

Question 7

A bond quote (quotation of price)

Answer 7

A bond quote = last price at which a bond is traded
% of par value and converted to a point scale
Besides market price, accrued interest (coupon bonds) play role.

Question 8

What are yield curves?

Answer 8

The relationship between time to maturity and corresponding interest rate
Since there is different interest rates for different time periods.
Yield curve displays the structure of interest rates.

Basic structure of interest rates is determined by government bond yields.

COnstructed for elements of the same levels of risk

Question 9

What are the 3 theories explaining the curve shapes and the 4 shapes of yield curves?

Answer 9

Pure expectation theory
Liquidity preference theory
Markets separation theory

Sloping
Inverted (downward sloping)
Flat
Humped

Question 10

Explain the 3 theories:

Answer 10

Pure expectation theory: This theory assumes that the various maturities are substitutes and the shape of the yield curve depends on the market’s

Expectation of future interest rates. According to this theory, yields tend to change over time, but the theory fails to define the details of yield curve shapes.“

Liquidity preference theory
„The concept gives a clear explanation for the upward sloping yield curve. Since investors strictly prefer liquidity, in order to persuade investors to buy long-term bonds over short-term bonds, the return offered by long-term bonds must be greater than the return offered by short-term bonds.“