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Questions and Answers
What happens to the price of a bond when interest rates fall?
What happens to the price of a bond when interest rates fall?
- The price of the bond decreases
- The price of the bond fluctuates randomly
- The price of the bond increases (correct)
- The price of the bond remains the same
Interest rate risk affects short-term bonds more than long-term bonds.
Interest rate risk affects short-term bonds more than long-term bonds.
False (B)
What is the price of a 7.50% coupon bond maturing in 4 years if interest rates fall to 2.00%?
What is the price of a 7.50% coupon bond maturing in 4 years if interest rates fall to 2.00%?
$1,209.43
If a bond's coupon rate is greater than the interest rate, the bond is said to be selling at a __________.
If a bond's coupon rate is greater than the interest rate, the bond is said to be selling at a __________.
Match the following bonds with their selling conditions:
Match the following bonds with their selling conditions:
What does the coupon rate indicate?
What does the coupon rate indicate?
The coupon rate is the same as the discount rate used in discounting cash flows.
The coupon rate is the same as the discount rate used in discounting cash flows.
What is the term for the amount paid to the bondholder at maturity?
What is the term for the amount paid to the bondholder at maturity?
The price of a bond is the present value of all __________ generated by the bond.
The price of a bond is the present value of all __________ generated by the bond.
In a bond calculation, the abbreviation 'cpn' stands for what?
In a bond calculation, the abbreviation 'cpn' stands for what?
Match the following bond terms with their definitions:
Match the following bond terms with their definitions:
In the example given, what is the required return for the bond calculation?
In the example given, what is the required return for the bond calculation?
The present value of a bond can be determined using financial calculator functions for time value of money.
The present value of a bond can be determined using financial calculator functions for time value of money.
What is the price percentage of a 7.50% annual coupon bond with a $1,000 face value that matures in 4 years and has a required return of 3.00%?
What is the price percentage of a 7.50% annual coupon bond with a $1,000 face value that matures in 4 years and has a required return of 3.00%?
A bond with semi-annual coupons has the same cash flow payments as one with annual coupons.
A bond with semi-annual coupons has the same cash flow payments as one with annual coupons.
If a bond has a 7.50% coupon rate and pays semi-annually, how much is each coupon payment?
If a bond has a 7.50% coupon rate and pays semi-annually, how much is each coupon payment?
The present value of the cash flows from the bond was calculated to be ______.
The present value of the cash flows from the bond was calculated to be ______.
Match the following terms with their definitions:
Match the following terms with their definitions:
How does the discount rate change when calculating the present value of semi-annual coupon payments?
How does the discount rate change when calculating the present value of semi-annual coupon payments?
The total cash flows from a bond with semi-annual coupons in the same period is less than those from annual coupon payments.
The total cash flows from a bond with semi-annual coupons in the same period is less than those from annual coupon payments.
What is the total number of coupon payments received if the bond matures in 4 years and pays semi-annually?
What is the total number of coupon payments received if the bond matures in 4 years and pays semi-annually?
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Study Notes
Bond Basics
- Bonds are securities that represent a loan from the bondholder to the issuer in exchange for specified payments.
- The face value or par value of a bond is the repayment amount at maturity.
- The coupon represents the interest payments made to the bondholder.
- The coupon rate is expressed as a percentage of the face value, representing annual interest payments.
- Important Note: The coupon rate is not the discount rate used in present value calculations; it simply indicates the cash flow generated by the bond.
Bond Pricing
- The price of a bond is calculated as the present value of all future cash flows generated by the bond (coupon payments and par value) discounted at the required rate of return.
- The formula for bond pricing is:
- PV = cnp / (1+r)^1 + ... + cnp / (1+r)^t + Par value / (1+r)^t
- cnp = coupon payment, r = required rate of return, t = time to maturity
- Bond calculations can be easily performed using financial calculators.
Interest Rates and Bond Prices
- Bond prices are inversely related to interest rates.
- When interest rates rise, the present value of future cash flows from a bond decreases, causing its price to fall.
- Conversely, when interest rates decline, the present value of those future cash flows rises, increasing the bond's price.
Interest Rate Risk
- The sensitivity of a bond's price to changes in interest rates increases with its maturity.
- Long-term bonds are more susceptible to interest rate risk than short-term bonds.
Premium and Discount Bonds
- When a bond's coupon rate is equal to the required rate of return, the bond is priced at par value.
- If a bond's coupon rate exceeds the required rate of return, the bond will be sold at a premium (higher than par value).
- If a bond's coupon rate is less than the required rate of return, the bond will be sold at a discount (lower than par value).
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