Finance 200 Chapter 6

The market-required rate of return on a bond that is held for its entire life is called the Yield to Maturity
All else held constant, the present value of a bond increases when the yield to maturity decreases
What is the principal amount of a bond that is repaid at the end of the loan term called? Face value
Which one of the following individuals is most apt to purchase a municipal bond? Highly compensated business owner
Which one of the following statements is true? A discount bond has a coupon rate that is less than the bond’s yield to maturity.
The rate of return an investor earns on a bond prior to adjusting for inflation is called the nominal rate.
The call premium is the amount by which the call price exceeds the par value.
A bond has a make-whole call provision. Given this, you know that the call price is inversely related to the market rate of interest
A call provision grants the bond issuer the option of repurchasing the bonds prior to maturity at a prespecified price.
The written agreement that contains the specific details related to a bond issue is called the bond indenture
Of these choices, a risk-adverse investor who prefers to minimize interest rate risk is most apt to invest in 2-year, 7 percent coupon bonds. (lowest year, highest %)
If inflation is expected to steadily decrease in the future, the term structure of interest rates will most likely downward sloping.
Which one of the following premiums is paid on a corporate bond due to its tax status? Taxability premium
The inflation premium: compensates investors for expected price increases.
Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected? Default risk premium
AB Builders has 15-year bonds outstanding with a face value of $1,000 and a market price of $974. The bonds pay interest annually and have a yield to maturity of 4.03 percent. What is the coupon rate? N = 15 x 2 = 30 I = 4.03 / 2 = 2.015 PV = -974 FV = 1,000PMT = ?PMT = 18.9918.99 x 2 = 37.9737.97 / 1,000 = .038 = 3.80%
A six-year, semiannual coupon bond is selling for $991.38. The bond has a face value of $1,000 and a yield to maturity of 9.19 percent. What is the coupon rate? N = 6 x 2 = 12I = 9.19 / 2 = 44.595PV = -991.38 FV = 1,000PMT = ? PMT = 44.9944.99 x 2 = 89.9989.99 / 1,000 = .90 = 9.00%
A 12-year, annual coupon bond is priced at $1,102.60. The bond has a $1,000 face value and a yield to maturity of 5.33 percent. What is the coupon rate? N = 12 x 2 = 24 I = 5.33 / 2 = 2.665 PV = -1,102.60 FV = 1,000PMT = ?PMT = 32.4932.49 x 2 = 64.9864.98 / 1,000 = .6498 = 6.51%
Fisher Effect formula (1 + R) = (1 + r*)(1 + h)R –> APRh –> inflation
A bond has a par value of $1,000, a current yield of 6.25 percent, and semiannual interest payments. The bond quote is 100.8. What is the amount of each coupon payment? 6.25 x 100.8 = 6.3%1,000 x .063 = 6363 / 2 = 31.5 per coupon payment
Current Yield Formula Annual Coupon / Current Price
Blue Water bonds have a face value of $1,000, a coupon rate of 6.5 percent, semiannual interest payments, and mature in 11.5 years. What is the current price of these bonds if the yield to maturity is 6.36 percent? N = 11.5 x 2 = 23 I = .0636 / 2PV = ?PMT = 1,000 x .065 = 65 / 2 = 32. 5 FV = 1,000PV = 1,011.30
A semiannual 5.4 percent coupon bond currently sells for par value. What is the maturity on this bond? The bond could have any maturity date.Note : Since the bond sells for par, the maturity is indeterminate.
The 6 percent semiannual coupon bonds of IPO, Inc., are selling for $1,087. The bonds have a face value of $1,000 and mature in 11 years. What is the yield to maturity? N = 11 x 2 = 22 I = ?PV = -1,087PMT = 1,000 x .06 = 60 / 2 = 30FV = 1,000I = 2.48 x 2 = 4.96
If Treasury bills are currently paying 2.84 percent and the inflation rate is 1.63 percent, what is the approximate real rate of interest? The exact real rate? Fisher Effect FormulaApproximate Real Rate:2.84 – 1.63 = 1.21%Exact Rate: ( 1+.0284%) / (1+.0163%) -1= 1.01190 -1= 1.19%
One year ago, you purchased a $1,000 face value bond for a clean price of $980. The bond currently has seven years remaining until maturity, pays a coupon payment of $45 every six months, and has a yield to maturity of 6.87 percent. What is the percentage change in the bond price over the past year? Bond Price = Coupon * {((1-((1/1+r)^t)/r) + (F/(1+r)^t) r = interets rate f= face value t= no of yrs Bond Price =45* {((1-((1/1+0.03435)^14)/0.03435) + (1000/(1+0.03435)^14)Bond Price =45*{(0.38/0.03435) +623.24} Bond Price =45*10.9683+623.24} Bond Price =$ 1,116.81 Original price = 980 Change in price = 1116.81-980=$ 136.8131 Increase of Change in price =136.8131/980* 100 =13.96%Answer is 13.96%
Name the two types of yield curves and how they differ. Normal Yield Curve – has an upward slope, and long term yields are HIGHER than short term yieldsInverted Yield Curve – has a downward slope, and long term yields are LOWER than short term yields
Real rates vs Nominal Rates Real rates – interest rates or rates of return that have been adjusted for inflationNominal rates – interest rates or rates of return that have NOT been adjusted for inflation
Coupon The stated interest payment made on a bond
Face Value Principal amount of a bond that is repaid at the end of the term.AKA – par value
Coupon Rate The annual coupon / face value of a bond
Maturity Specified date on which the principal amount of a bond is paid
Yield to Maturity Rate required in the market for a bond
Current Yield bond’s coupon payment / closing price
Indenture Written agreement between a corporation and the lender detailing the terms of the debt issue.
What does an indenture include? An indenture includes:1. Basic terms of the bonds2. Total amount of the bond issued3. Description of property used as security.4. Repayment arrangements5. Call provisions6. details of the protective covenant
Debenture Unsecured debt, usually with at least 10 years of maturity.
Sinking fund An account managed by the bond trustee for an early bond redemption
Call provision Agreement giving the bond seller the option to but back the bond at a specific price prior to maturity.
Call premium Amount by which the call price exceeds the par value of the bond
Deferred call provision Bond call provision prohibiting the company from redeeming the bond prior to a certain date
Call protected bond Bond during period in which it cannot be redeemed by the issuer
Zero coupon bond A bond that makes no coupon payments and is priced at a large discount
Convertible bond Can be swapped for a fixed number of shares of stock anytime before the maturity date.
Inflation premium The portion of a nominal interest rate that represents compensation for expected future inflation
Interest rate risk premium The compensation investors demand for bearing interest rate risk.
Treasury Yield Curve Plot of the yields on treasury notes and bonds relative to maturity
Default risk premium Portion of a nominal interest rate or bond yield that represents compensation for the possibility of default.
Taxability Premium Portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status.
Liquidity Premium Portion of a nominal interest rate or bond yield that represents compensation lack of liquidity.

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