Module 5 - Chapter 7 Flashcards
Define:
Bond
A contract between two parties:
One is an investor (you) and the other is a company or government agency borrowing the money
Define:
Par Value
Face amount; amount paid at maturity
Answer:
What do we assume par value to be?
$1,000
Define:
Coupon Interest Rate
Stated interest rate
Multiply coupon interest rate by par value to get dollars of interest
Generally fixed
Define:
Maturity
Years until a bond must be repaid
Answer:
Maturity ______ as time passes
declines
Define:
Issue Date
Date when bond was issued
Define:
Default Risk
Risk that issuer will not make interest or principal payments
Answer:
What is the primary type of risk for a bond?
Default risk
Define:
Call Provision
Issuer can refund if rates decline
Answer:
A call provision helps the ___(a)___, but hurts the ___(b)___
a. issuer
b. investor
Answer:
Once you have calculated the ___(a)___ you no longer need the ___(b)___
a. annuity amount
b. coupon rate
Answer:
If the coupon interest rate exactly equals the discount rate, ______
the bond value today will always equal par
Define:
Discount Bond
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)
Define:
Premium Bond
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)
Answer:
If discount rate equals coupon interest rate than the present value is ___(a)___ par value and the bond sells at ___(b)___
a. equal to
b. par value
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. less than
b. premium
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. greater than
b. discount
Answer:
The relationship between discount rate and present value is ______
inverse
Answer:
If the discount rate goes up, the present value goes ______
down
Answer:
If the discount rate goes down, the present value goes ______
up
Answer:
The current yield is the ___(a)___ divided by the ___(b)___
a. annual coupon rate
b. current price
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. greater
b. a call
Answer:
Discount rate for premium bonds is called _____
YTC - rate to call
Answer:
Discount rate for discount bonds is ______
YTM - rate to maturity
Define:
Risk Free Bonds
no chance of default by the issuer
generally are treasury bonds
Define:
Risky Bonds
Have a chance of default by the borrower
Generally are corporate bonds
List:
Step in valuing a corporate bond
- Write down the cash flows
- Determine appropriate discount rate (Coupon Rate * Par Value)
- Calculate the PV
Answer:
How do you determine the appropriate discount rate of a bond?
Coupon Rate * Par Value
Answer:
Discount rate on a corporate bond should be ___(a)___ than a treasury bond with the same ___(b)___ because corporate bonds carry ___(c)___
a. higher
b. maturity
c. default risk
Answer:
Discount rate of corporate bonds is ______ discount rate of treasury bonds
greater than
Answer:
Why is the discount rate of corporate bonds greater than the discount rate of treasury bonds?
Because corporate bonds care default risk
Define:
Default Risk
Risk that the borrower (usually corporation) may not make all scheduled payments
Define:
Yield Spread between Treasury and Corporate Bonds
The difference in yield to maturity between two bonds or classes of bonds with similar maturity
Answer:
With semiannual bonds, how do you calculate n?
multiply years by 2
Answer:
With semiannual bonds how do you get periodic rate?
Divide nominal rate by 2
Answer:
With semiannual bonds, how you get PMT?
Divide annual r (interest earned) by 2
Acronym:
rd
(component of required rate of return)
required rate of return on debt security
Acronym:
r*
(component of required rate of return)
real risk free rate
Acronym:
IP
(component of required rate of return)
inflation premium
Acronym:
DRP
(component of required rate of return)
default risk premium
Acronym:
LP
(component of required rate of return)
liquidity premium
Acronym:
MRP
(component of required rate of return)
maturity risk premium
Answer:
Maturity risk premium is a _______
period of time
Define:
Liquidity Premium
how easy it is to sell or buy a bond
Define:
Default Risk Premium
Probability firm will no be able to make payments
Define:
The Fisher Effect
defines the relationship between real rate, nominal rates, and inflation
Acronym:
R
(The Fisher Effect)
nominal rate
Acronym:
r
(The Fisher Effect)
real rate
Acronym:
h
(The Fisher Effect)
expected inflation rate
AnswerL
Because the real rate of return and expected inflation rate are relatively high, there is _______
significant difference between the actual Sigher Effect and the approximation
Define:
Reinvestment Rate Risk
The risk CFs will have to be reinvested in the suture at lower rates, reducing income
AcronymL
MRP
Maturity Risk Premium
Define:
MRP Long Term Bonds
High interest rate risk, low reinvestment rate risk
Define:
MRP Short Term Bonds
Low interest rate risk, high reinvestment rate risk
Answer:
Yields on longer term bonds are usually ___(a)___ than on shorter term bonds, so the MRP is ___(b)___ on longer term bonds
a. greater
b. more affected by the interest rate risk than by reinvestment rate risk
Answer:
With long term bond MRP interest rate risk ___(a)___ and reinvestment rate risk ___(b)___, so yields are usually ___(c)___
a. increases
b. decreases
c. higher
Answer:
With short term bond MRP interest rate risk ___(a)___ and reinvestment rate risk ___(b)___, so yields are usually ___(c)___
a. decreases
b. increases
c. lower
Define:
Term Structure of Interest Rates
the relationship between interest rates (or yields) and maturities
Define:
Yield Curve
A graphical representation of the term structure
