Topic Quiz 6

Question 1

A bond with a face value of $5,000 has a coupon rate of 5% p.a.. What is the dollar value of the coupon if the coupons are paid semi-annually?

Answer 1

C = 0.05×5,000/ 2
= $125

Question 2

A bond with a face value of $2,000 has a coupon rate of 6% p.a.. What is the dollar value of the coupon if the coupons are paid quarterly?

Answer 2

C = 0.06×2,000/ 4
= $30

Question 3

Consider a 3-year bond with a face value of $500 and an annual coupon rate of 5%pa. The ZCB yield is the same for all of the terms and is 4%p.a. What is the price of this bond?

Question 4

What of the following is a zero-coupon paying bond?

a. A bond that only pays coupons.
b. A bond that only pays a face value.
c. A bond issued by the government.

Answer 4

b. A bond that only pays a face value.

Question 5

The one year zero coupon bond yield is 1.5%. What is the value of a one year zero coupon bond that has a face value of $100?

a. $95.34
b. $98.52
c. $100

Answer 5

P$(t) = Discount Factor = 1/ [ 1 + y(t))^t ]

If:
y(t) = 1.5% = 0.015
t = 1
P$(t) = 1/ [(1+0.015)^1] = 0.9852

Price = P = F x P$(t)
= 100 x 0.9852
= $98.52

b. $98.52

Question 6

A six-year Treasury bond pays coupons semi-annually. Are the following statements true or false?

a. This bond is made of twelve zero coupon bonds.
b. This bond will trade at a discount to its face value.
c. This bond will trade at a higher yield than that corporate bond.

Answer 6

a. This bond is made of twelve zero coupon bonds. (TRUE)

b. This bond will trade at a discount to its face value. (FALSE, insufficient information)

c. This bond will trade at a higher yield than that corporate bond. (FALSE)

Question 7

What would you use to calculate a one-year forward yield out of five years?

a. A one-year zero coupon bond yield and a five-year zero-coupon bond yield.
b. A spot yield and a six-year zero coupon bond yield.
c. A five-year zero-coupon bond yield and a six-year zero coupon bond yield.

Answer 7

One year forward yield out of five years means end date is end of six years.

Two strategies give same payoff, same level of risk and same price today.

Strategy 1 = six-year zero coupon bond yield
Strategy 2 = five-year zero-coupon bond yield, then reinvest payoff at end of five years into a one-year zero coupon bond.

c. A five-year zero-coupon bond yield and a six-year zero coupon bond yield.

Question 8

What is a bond that pays high coupon rates but will not be fully repaid if an event occurs?

a. A putable bond
b. A callable bond
c. A catastrophe bond
d. A convertible bond

Answer 8

c. A catastrophe bond

Question 9

How do you calculate the forward yield for year 5 to year 6?

a. You deduct a one year ZCB yield from a six year ZCB yield.
b. You use a five year forward yield and six year forward yield.
c. You use the yields on a five year ZCB and a six year ZCB.
d. You add a one year ZCB yield to a five year ZCB yield.

Answer 9

c. You use the yields on a five year ZCB and a six year ZCB.

Question 10

What is a characteristic of a corporate bond?

a. Their face value can be fixed or indexed to inflation.
b. They are not subject to indentures.
c. They are easier to price when default risk is taken into account.
d. They can be reverse floaters.

Answer 10

a. Their face value can be fixed or indexed to inflation.

Question 11

An investor buys a ZCB with a face value of $100 and a term of 5 years. How much will they pay for the ZCB if it is trading at a yield of 1.25%?

a. $106.41
b. $93.98
c. $98.77
d. $100.00

Answer 11

P$(t) = Discount Factor = 1/ [ 1 + y(t))^t ]

If:
y(t) = 1.25% = 0.0125
t = 5
P$(t) = 1/ [(1+0.0125)^5] = 0.9398

Price = P = F x P$(t)
= 100 x 0.9393
= $93.98

b. $93.98

Question 12

What are corporate bonds?

a. Securities settled at 5 days after the trade date.
b. Risk free securities
c. Fixed income securities
d. Fixed dividend securities

Answer 12

c. Fixed income securities

Question 13

Why are zero coupon bond yields also known as spot yields?

Answer 13

Zero coupon bonds are single payment interest rate securities whose term starts today. Forward yields are yields on interest rate securities whose term starts at a later date.

Question 14

What is an inverse floater corporate bond?

Answer 14

This is a corporate bond whose coupon rate will increase when interest rates in the market decrease. The coupon rate will decrease when interest rates in the market increase.

Question 15

Are bonds listed on the ASX traded in terms of their price or yield?

Answer 15

The ASX trades bonds in terms of their price.

In the over the counter bond market, bonds are traded in terms of their yields. So in the bond market dealers will quote yields not price.

Question 16

Why would a bank use forward yields to hedge against refinancing risks?

Answer 16

Banks accept short term deposits (liabilities) and make longer term loans (assets). Banks can use forward yields to preset the yield needed to refinance loans.

Question 17

When do Catastrophe bonds stop making payments to the investors that hold them?

Answer 17

When the catastrophe covered by the bonds, such as an earthquake which bonds issued by Tokyo Disneyland covered, occurs. After the catastrophe occurs the remaining coupons and face value will not be paid.

Question 18

Do you pay a premium or a discount for zero coupon bonds?

Answer 18

You pay a discount so the bond’s price will be less than its face value. This is because the only payment made by a zero coupon bond is its face value at maturity.

Question 19

What is the main reason for the Australian government to issue Treasury bonds?

Answer 19

To finance a budget deficit so that large scale projects can be undertaken.

Question 20

What do you call the yield of an interest rate security whose term starts in three years time and ends in five years time?

Answer 20

A two year forward yield out of three years.

Question 21

What is the relationship between yields on zero coupon bonds and their term known as?

Answer 21

The relationship is known as the term structure of yields. It shows the yields on single payment securities that are identical apart from their term.

Question 22

Do convertible bonds have a lower or higher coupon rate than non-convertible bonds?

Answer 22

They will have a lower coupon rate due to their potential to be more profitable than a normal bond. A convertible bond will be more profitable when its conversion value is greater than the bonds price.