Volume 1- Chapter 7 Flashcards
What is the most accurate method used to determine the value of a bond?
Calculate the present value.
What does present value represent in bond pricing?
The amount an investor should pay today to invest in a security that offers a guaranteed sum of money on a specific date in the future.
If you want to receive $1,000 one year from today with an interest rate of 5%, what is the present value?
$952.38
List the four steps to calculate the present value of a bond with coupon payments.
- Choose the appropriate discount rate. * Calculate the present value of the income stream from the bond’s coupon payments. * Calculate the present value of the bond’s principal to be received at maturity. * Add these present values together to determine the bond’s worth today.
What is the general formula used to calculate the present value of a bond?
(C1 / (1+r)^1) + (C2 / (1+r)^2) + … + (Cn / (1+r)^n) + (FV / (1+r)^n)
What does the discount rate represent in bond valuation?
The rate at which you would discount a future value to determine the present value.
True or False: The discount rate and yield can be used interchangeably.
True
What must be adjusted if a bond pays interest more than once a year?
Coupon payments, compounding periods, and the discount rate must be adjusted.
In a four-year, semi-annual, 9% bond, what is the coupon payment per period?
$4.50
What is the fair price of a bond?
The present value of the bond’s principal and the present value of all coupon payments to be received over the life of the bond.
How is the present value of a bond calculated?
By discounting the cash flows (coupon payments and principal) back to the present.
What is the present value of the income stream for a bond with eight $4.50 coupon payments?
$29.08
What does a negative value in time value of money calculations denote?
An outflow of money.
What is the present value of the principal for a bond with a par value of $100?
$67.68
What is the present value of the bond if the present value of the coupons is $29.08 and the principal is $67.68?
$96.77
How do you calculate the present value of a series of coupon payments?
Using the formula for the present value of an annuity.
Fill in the blank: The appropriate discount rate changes with ______.
changing economic conditions.
What does the term ‘coupon rate’ refer to?
The income to be paid to the bondholder, set when the bond is issued.
What is the principal received at maturity in bond valuation?
The future value (FV) of the bond.
How many compounding periods are there in a four-year, semi-annual bond?
8 compounding periods.
What is the formula for calculating the present value of an annuity?
APV = C * [(1 - (1 + r)^-n) / r]
What is the present value of the income stream calculated in the example?
$29.084
What two sources of value make up the fair price of a bond?
- Present value of its principal
- Present value of its coupons
At a discount rate of 10%, what is the value of the bond calculated?
$96.77