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Financial Management > Module 5 - Chapter 7 > Flashcards

Module 5 - Chapter 7 Flashcards

1
Q

Define:

Bond

A

A contract between two parties:

One is an investor (you) and the other is a company or government agency borrowing the money

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2
Q

Define:

Par Value

A

Face amount; amount paid at maturity

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3
Q

Answer:

What do we assume par value to be?

A

$1,000

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4
Q

Define:

Coupon Interest Rate

A

Stated interest rate

Multiply coupon interest rate by par value to get dollars of interest

Generally fixed

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5
Q

Define:

Maturity

A

Years until a bond must be repaid

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6
Q

Answer:

Maturity ______ as time passes

A

declines

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7
Q

Define:

Issue Date

A

Date when bond was issued

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8
Q

Define:

Default Risk

A

Risk that issuer will not make interest or principal payments

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9
Q

Answer:

What is the primary type of risk for a bond?

A

Default risk

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10
Q

Define:

Call Provision

A

Issuer can refund if rates decline

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11
Q

Answer:

A call provision helps the ___(a)___, but hurts the ___(b)___

A

a. issuer

b. investor

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12
Q

Answer:

Once you have calculated the ___(a)___ you no longer need the ___(b)___

A

a. annuity amount

b. coupon rate

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13
Q

Answer:

If the coupon interest rate exactly equals the discount rate, ______

A

the bond value today will always equal par

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14
Q

Define:

Discount Bond

A

Bond there YTM is greater than (>) coupon interest rate

or (depending on info given)

The calculated present value of the bond is less than par value ($1,000)

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15
Q

Define:

Premium Bond

A

Bond where TYM is less than coupon interest value ($1,000)

Or (depending on info given)

Present value is greater than par value ($1,000)

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16
Q

Answer:

If discount rate equals coupon interest rate than the present value is ___(a)___ par value and the bond sells at ___(b)___

A

a. equal to

b. par value

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17
Q

Answer:

If the discount rate is less than the coupon interest rate then present value is ___(a)___ par value and the bond sells at ___(b)___

A

a. less than

b. premium

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18
Q

Answer:

If discount rate (YTM) is greater than coupon interest rate, the present value of the bond is ___(a)___ par value and the bond sells at ___(b)___

A

a. greater than

b. discount

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19
Q

Answer:

The relationship between discount rate and present value is ______

A

inverse

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20
Q

Answer:

If the discount rate goes up, the present value goes ______

A

down

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21
Q

Answer:

If the discount rate goes down, the present value goes ______

A

up

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22
Q

Answer:

The current yield is the ___(a)___ divided by the ___(b)___

A

a. annual coupon rate

b. current price

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23
Q

Answer:

In general, if a bond sells at premium then the coupon rate is ___(a)___ than the discount rate, so ___(b)___ is more likely

A

a. greater

b. a call

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24
Q

Answer:

Discount rate for premium bonds is called _____

A

YTC - rate to call

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25
Q

Answer:

Discount rate for discount bonds is ______

A

YTM - rate to maturity

26
Q

Define:

Risk Free Bonds

A

no chance of default by the issuer

generally are treasury bonds

27
Q

Define:

Risky Bonds

A

Have a chance of default by the borrower

Generally are corporate bonds

28
Q

List:

Step in valuing a corporate bond

A
  1. Write down the cash flows
  2. Determine appropriate discount rate (Coupon Rate * Par Value)
  3. Calculate the PV
29
Q

Answer:

How do you determine the appropriate discount rate of a bond?

A

Coupon Rate * Par Value

30
Q

Answer:

Discount rate on a corporate bond should be ___(a)___ than a treasury bond with the same ___(b)___ because corporate bonds carry ___(c)___

A

a. higher
b. maturity
c. default risk

31
Q

Answer:

Discount rate of corporate bonds is ______ discount rate of treasury bonds

A

greater than

32
Q

Answer:

Why is the discount rate of corporate bonds greater than the discount rate of treasury bonds?

A

Because corporate bonds care default risk

33
Q

Define:

Default Risk

A

Risk that the borrower (usually corporation) may not make all scheduled payments

34
Q

Define:

Yield Spread between Treasury and Corporate Bonds

A

The difference in yield to maturity between two bonds or classes of bonds with similar maturity

35
Q

Answer:

With semiannual bonds, how do you calculate n?

A

multiply years by 2

36
Q

Answer:

With semiannual bonds how do you get periodic rate?

A

Divide nominal rate by 2

37
Q

Answer:

With semiannual bonds, how you get PMT?

A

Divide annual r (interest earned) by 2

38
Q

Acronym:

rd

(component of required rate of return)

A

required rate of return on debt security

39
Q

Acronym:

r*

(component of required rate of return)

A

real risk free rate

40
Q

Acronym:

IP

(component of required rate of return)

A

inflation premium

41
Q

Acronym:

DRP

(component of required rate of return)

A

default risk premium

42
Q

Acronym:

LP

(component of required rate of return)

A

liquidity premium

43
Q

Acronym:

MRP

(component of required rate of return)

A

maturity risk premium

44
Q

Answer:

Maturity risk premium is a _______

A

period of time

45
Q

Define:

Liquidity Premium

A

how easy it is to sell or buy a bond

46
Q

Define:

Default Risk Premium

A

Probability firm will no be able to make payments

47
Q

Define:

The Fisher Effect

A

defines the relationship between real rate, nominal rates, and inflation

48
Q

Acronym:

R

(The Fisher Effect)

A

nominal rate

49
Q

Acronym:

r

(The Fisher Effect)

A

real rate

50
Q

Acronym:

h

(The Fisher Effect)

A

expected inflation rate

51
Q

AnswerL

Because the real rate of return and expected inflation rate are relatively high, there is _______

A

significant difference between the actual Sigher Effect and the approximation

52
Q

Define:

Reinvestment Rate Risk

A

The risk CFs will have to be reinvested in the suture at lower rates, reducing income

53
Q

AcronymL

MRP

A

Maturity Risk Premium

54
Q

Define:

MRP Long Term Bonds

A

High interest rate risk, low reinvestment rate risk

55
Q

Define:

MRP Short Term Bonds

A

Low interest rate risk, high reinvestment rate risk

56
Q

Answer:

Yields on longer term bonds are usually ___(a)___ than on shorter term bonds, so the MRP is ___(b)___ on longer term bonds

A

a. greater

b. more affected by the interest rate risk than by reinvestment rate risk

57
Q

Answer:

With long term bond MRP interest rate risk ___(a)___ and reinvestment rate risk ___(b)___, so yields are usually ___(c)___

A

a. increases
b. decreases
c. higher

58
Q

Answer:

With short term bond MRP interest rate risk ___(a)___ and reinvestment rate risk ___(b)___, so yields are usually ___(c)___

A

a. decreases
b. increases
c. lower

59
Q

Define:

Term Structure of Interest Rates

A

the relationship between interest rates (or yields) and maturities

60
Q

Define:

Yield Curve

A

A graphical representation of the term structure

Financial Management (3 decks)

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