Week 2

Question 1

If bond prices increase, interest rates….

Answer 1

decrease

Question 2

If interest rates increase, bond prices….

Answer 2

decrease, bonds will trade at discount to par

Question 3

If bond prices decrease, interest rates….

Answer 3

increase

Question 4

If interest rates decrease, bond prices….

Answer 4

increase, bonds will trade at a premium to par

Question 5

What is a bond?

Answer 5

debt contract where the borrower (issuer) borrows a predetermined amount and pays periodic interest on loan

Question 6

What is the coupon rate?

Answer 6

rate of interest being paid on face value quoted as an APR

Question 7

What is YTM?

Answer 7

Yield to maturity is the discount rate for a bond

Question 8

What is maturity?

Answer 8

date which the loan is repaid

Question 9

what are the three components of discount rate?

Answer 9

inflation
Opportunity cost
default risk

Question 10

What is inflation?

Answer 10

rate of interest on investment with repayment in the future

Question 11

What is oppourtunity cost?

Answer 11

financial markets are subject to supply and demand
Lots of investors with money to lend, OC typically low
During contraction less investors, OC increases

Question 12

Inflation + Opportunity cost =

Answer 12

Risk-free rate

Question 13

What is risk-free rate of return?

Answer 13

reflects inflation and opportunity cost collectively such an investment has zero default risk

Question 14

What is default risk?

Answer 14

rate of interest must adequately compensate the investor for bearing the risk that the borrowing company or government will be unable to repay the loan and default on the contract

Question 15

Higher default risk becomes

Answer 15

higher interest rates demanded by investors

Question 16

What is the value of a bond?

Answer 16

PV of all future cash flows (PV of all remaining interest payments and the final face value payment)

Question 17

Buying a bond after it is issued gives the right to…

Answer 17

all future interest payments and FV payments

Question 18

Coupon payments are

Answer 18

annuity

Question 19

T/F: Once a bond is issued coupon rates can change over time while the yield to maturity typically remains constant

Answer 19

False

Question 20

T/F: When a bond is issued the coupon rate and the yield to maturity are normally equal

Answer 20

True

Question 21

If the issuer of a bond is viewed to have a higher default likelihood now than when the bond was issued the yield to maturity will be _______ than when the bond was issued and the bond value will be ____ than its face value.

Answer 21

Higher, lower

Question 22

You expect that interest rates are going to decrease due to a shift in inflation expectations. You have two bonds you are considering buying, the only difference is one matures in 10 years and the other matures in 5 years. Which would you prefer?

Answer 22

10 year maturity bond

Question 23

Does YTM change over time?

Answer 23

Yes, but it is compensated for bearing risk (coupon payments don’t change)

Question 24

YTM lower than coupon rate, value is higher than its face value, bond is trading at…

Answer 24

premium
Investors are overcompensated for the risk they are bearing
(default risk, inflation expectations or opportunity costs have decreased since the bond was issued)

Question 25

YTM higher than coupon rate bond will trade at a value lower than face value, bond is trading at…

Answer 25

discount

Factors have increased since the bond was issued