Unit 5

Question 1

Key characteristics of Bonds

Answer 1

fluctuates due to interest rate and time to maturity

Question 2

par value

Answer 2

amount of money holder will get back once a bond matures

Question 3

pull to par

Answer 3

effect in which price of a bond converges to par value as time passes; reduction of maturity

Question 4

callable bond

Answer 4

issuer can redeem bond before maturity date; redeemable bond; likely happens when interest rates go down; may contain embedded options

Question 5

sinking funds

Answer 5

funds which money can be deposited so that preferred stock, debentures, or stocks can be retired; reduces credit risk; presents reinvestment risk to bondholders

Question 6

debenture

Answer 6

document that creates/acknowledges debt and is a debt without collateral

Question 7

What happens to bond prices when interest rates go down?

Answer 7

Bond prices increase; firms benefit from repurchasing bonds at below-market prices

Question 8

Putablility

Answer 8

repay bond before maturity date on put dates; retractable bonds; protects investors if interest rate increases after purchase, future value of coupon payments become less valuable

Question 9

Money market instruments

Answer 9

less than one year; T-bills

Question 10

Time to maturity

Answer 10

long term bonds are 12 + years long; most sensitive to interest rate changes; risk is higher

Question 11

Refunding bonds

Answer 11

issuer calls them to issue new debt at lower price; occurs when interest rates in market are sufficiently less than coupon rate; occurs when price of old bond is less than par; occurs when sinking fund accumulated enough money to retire bond issue

Question 12

Whether to make refunding decision

Answer 12

interest savings; calculate net investment; net present value refunding

Question 13

Bond Risk

Answer 13

Bond prices move in opposite directions of interest rate; zero coupon; issuer’s credit rating; market interest rate; time to maturity

Question 14

Price risk

Answer 14

risk that the market price of a bond will fall due to increase in market interest rate; doesn’t affect interest payments to bondholder; immediately affects mutual funds

Question 15

Reinvestment risk

Answer 15

risk resulting from the fact that interest or dividends earned from an investment may not be able to be reinvested in a way that they earn the same rate of return; more likely when interest rates are declining; affects yield-to-maturity of bond

Question 16

Default risk/credit risk

Answer 16

risk that bond issuer will default on any type of debt by failing to make payments which it is obligated to make