Bond Fundamentals and Concepts Quiz
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Questions and Answers

Which of the following is an example of a coverage ratio?

  • Profitability ratio
  • Debt ratio
  • Interest coverage ratio (correct)
  • Current ratio
  • What defines reinvestment rate risk?

  • The risk of economic downturn affecting investment income
  • The risk of reinvesting cash flows at lower interest rates (correct)
  • The risk of not having enough cash flow to meet expenses
  • The risk associated with fluctuating exchange rates
  • Which type of bond has a higher claim on assets in the event of liquidation?

  • Common equity
  • Subordinated debt
  • Unsecured debt
  • Secured debt (correct)
  • What is the term structure of interest rates primarily concerned with?

    <p>The relationship between interest rates and maturities</p> Signup and view all the answers

    Which of the following factors does NOT affect bond ratings?

    <p>Market share of the issuing company</p> Signup and view all the answers

    What is the par value of a bond?

    <p>The face amount paid at maturity</p> Signup and view all the answers

    Which of the following describes the maturity of a bond?

    <p>The years until the bond must be repaid</p> Signup and view all the answers

    What does a bond's coupon interest rate represent?

    <p>The stated interest rate applied to the par value</p> Signup and view all the answers

    What is default risk in the context of bonds?

    <p>The chance that the issuer will fail to make payments</p> Signup and view all the answers

    What is a call provision in a bond?

    <p>The option for the issuer to buy back the bond if rates fall</p> Signup and view all the answers

    Which component is not typically considered a key feature of bonds?

    <p>Market capitalization</p> Signup and view all the answers

    How is the yield of a bond typically measured?

    <p>Based on the coupon payment relative to the market price</p> Signup and view all the answers

    What happens to bond prices when market interest rates increase?

    <p>Bond prices decrease as rates go up.</p> Signup and view all the answers

    What does yield to maturity (YTM) represent?

    <p>The rate of return on a bond held until maturity.</p> Signup and view all the answers

    For a bond with a coupon rate higher than the market interest rate, how is the bond priced?

    <p>At a premium.</p> Signup and view all the answers

    What relationship does the price of a coupon bond have with the years remaining to maturity?

    <p>Price equals face value at maturity.</p> Signup and view all the answers

    In the given example with a bond that has a face value of $1000 and a coupon rate of 9%, what is its price if interest rates increase to 14%?

    <p>$692.89</p> Signup and view all the answers

    In calculating the price of a coupon bond, what does 'C' represent?

    <p>Coupon payment received periodically.</p> Signup and view all the answers

    What will likely happen to the price of a bond if inflation decreases?

    <p>The price of the bond will likely increase.</p> Signup and view all the answers

    When a bond is sold below its par value, what is it classified as?

    <p>Discount bond.</p> Signup and view all the answers

    What happens to the price of a bond when market interest rates increase?

    <p>The bond price decreases.</p> Signup and view all the answers

    How is the current yield of a bond calculated?

    <p>Annual coupon payment divided by the current price.</p> Signup and view all the answers

    What is the formula for calculating capital gains yield?

    <p>Change in price divided by beginning price.</p> Signup and view all the answers

    If a bond has a yield to maturity (YTM) of 10.91%, what does this indicate?

    <p>The bond is expected to yield 10.91% over its entire life.</p> Signup and view all the answers

    What is the effect of changing from annual to semiannual coupon payments?

    <p>Periods double, and the nominal rate is halved.</p> Signup and view all the answers

    What factors affect the default risk and bond ratings?

    <p>Issuer's financial health and market conditions.</p> Signup and view all the answers

    When calculating the yield to call (YTC) for a callable bond, what components are used in the formula?

    <p>Years to maturity, payment, current price, and call price.</p> Signup and view all the answers

    What is the relationship between yield to maturity and bond price?

    <p>Higher YTM corresponds to a lower bond price.</p> Signup and view all the answers

    What is the primary feature of callable bonds that affects both issuers and investors?

    <p>They can be redeemed before maturity, benefiting issuers.</p> Signup and view all the answers

    What does the yield to maturity (YTM) represent for a bond?

    <p>The rate of return an investor earns by holding the bond to maturity.</p> Signup and view all the answers

    How is the cash flow of a zero-coupon bond typically structured?

    <p>It pays the face value only at maturity.</p> Signup and view all the answers

    What calculation is necessary to determine the price of a zero-coupon bond?

    <p>Calculating the present value of its face amount using the yield to maturity.</p> Signup and view all the answers

    For a 10-year bond with a face value of Rs 1000 and a coupon rate of 5.5% with semi-annual payments, what is the coupon payment?

    <p>Rs 27.50</p> Signup and view all the answers

    What typically characterizes a deferred call feature in bonds?

    <p>The issuer cannot call the bond until a specified period elapses.</p> Signup and view all the answers

    What is the implication of the yield curve for zero-coupon bonds?

    <p>It helps in determining the price of zero-coupon bonds based on their yield to maturity.</p> Signup and view all the answers

    What is a common risk associated with callable bonds for investors?

    <p>The bond may be called away when interest rates drop.</p> Signup and view all the answers

    What is the annual yield to maturity (YTM) for a bond with a face value of $1,000, priced at $1,050, and has a coupon rate of 6% with 10 years to maturity?

    <p>5.4%</p> Signup and view all the answers

    If a bond sells at a premium, which statement is true?

    <p>The price of the bond is greater than its face value.</p> Signup and view all the answers

    How is the yield to maturity (YTM) impacted if a bond’s coupon rate is lower than the market interest rates?

    <p>The YTM will be higher than the coupon rate.</p> Signup and view all the answers

    What is the effect of an increase in market interest rates on the price of existing bonds?

    <p>The price of existing bonds will decrease.</p> Signup and view all the answers

    Calculating the YTM, which formula is used for a bond that pays coupons semi-annually?

    <p>[$C + (($FV - PV) ÷ N)] / [($FV + PV) ÷ 2]</p> Signup and view all the answers

    Which bond would likely trade at a discount if yields are at 5%?

    <p>Bond with a 3% coupon rate.</p> Signup and view all the answers

    What is the YTM approximation method formula considering a bond with a current selling price of 963.11 and a face value of 1000 with 5 years to maturity?

    <p>(11 + (1000 - 963.11) / 10) / ((1000 + 963.11) / 2)</p> Signup and view all the answers

    Given a semi-annual coupon bond with a face value of Rs 1000 and a coupon rate of 2.2%, what would the yield to maturity (YTM) be using the shortcut method?

    <p>1.5%</p> Signup and view all the answers

    Study Notes

    Bond Valuation

    • Bonds are debt instruments issued by a company or government.
    • Investors lend money in exchange for receiving periodic interest payments.
    • The initial investment is repaid at maturity.
    • Bonds are a form of fixed-income investment with predictable returns.
    • Investors use bonds to diversify their portfolios and generate additional income.

    Types of Bonds

    • Corporate Bonds
    • Municipal Bonds
    • Treasury Bonds
    • Junk Bonds
    • Bond Funds

    Advantages of Bonds

    • Receive income through interest payments.
    • Hold the bond to maturity to get the principal back.
    • Can profit if you resell the bond at a higher price.

    Disadvantages of Bonds

    • Bonds pay out lower returns than stocks.
    • Companies may default on bonds.
    • Bond yields can fall.

    Bond Terminology

    • Bond Certificate: Outlines the bond's terms and payment details.
    • Coupons: Periodic interest payments. Usually semiannual. Determined by the coupon rate stated on the certificate.
    • Coupon Rate x Face Value = Amount Paid
    • Maturity Date: Bond's final payment date.
    • Principal/Face Value: The notional amount used to compute interest, usually repaid at maturity.
    • Term: Time remaining until repayment.

    Key Features of a Bond

    • Par Value: Face amount paid at maturity.
    • Coupon Interest Rate: Stated interest rate. Multipling by par value determines the dollars/rupees of interest. Generally fixed.
    • Maturity: Years until bond repayment. Declines over time.
    • Issue Date: Bond's issuance date.
    • Default Risk: Risk of issuer missing interest or principal payments or both.

    Sample Bond Issue (Example)

    • Specific example of NTPC Ltd. bond details
      • Coupon Rate: 8.91%
      • Face Value: ₹1,000
      • Maturity Date: 16-Dec-2033
      • Last Traded Price: ₹1,367.80
      • Last Traded Date: 29-Nov-2024
    • Other data points included

    Call Provision

    • Issuers can refund if interest rates fall. This benefits the issuer but harms the investor.
    • Consequently, borrowers are willing to pay more, and lenders require more on callable bonds.
    • Most bonds have a deferred call.

    Bond Issue in India

    • Links to websites providing information on bond issues in India.

    Class Problem - 1 (Description)

    • Describes a specific bond with specified details.
    • Asks for the coupon payment calculation.
    • Requests a cash flow timeline diagram for the bond.

    Class Exercise - 2 (Description)

    • Presents a timeline of payments for a bond.
    • Questions on maturity, coupon rate, and face value calculations.

    Zero-Coupon Bond Cash Flows

    • Cash flows for zero-coupon bonds are described

    Yield to Maturity (YTM)

    • The rate of return on a bond held to its maturity date.
    • The discount rate that makes the present value of the bond payments equal to the current market price.

    Yield to Maturity of an n-Year Zero-Coupon Bond

    • Mathematical formula for calculating YTM of a zero-coupon bond

    Example Yields to Maturity

    • Numerical example demonstrating calculation of yield to maturity for a one-year zero-coupon bond.

    Class Exercise - 3 (Description)

    • Presents various zero-coupon bonds with maturity and prices.
    • Requires calculation of the yield to maturity.

    Class Problem - 2 (Description)

    • Presents a table of zero-coupon bond prices.
    • Asks for calculating the yield to maturity for each bond

    Zero-Coupon Yield Curve Description

    Computing the Price of a Zero-Coupon Bond

    Price of a Coupon Bond

    • Explains the formula for calculating the price of a coupon bond
    • Includes details on bond price

    Class Example (Description)

    Yield to Maturity of a Coupon Bond

    Cash Flow of Coupon Bond

    Price of a Coupon Bond

    Class Example (Description)

    Example of a Bond (Description)

    Finding our current price/MP of the Bond

    What would happen if inflation goes up

    What would happen if inflation fell

    Bond Value ($) vs. Years Remaining to Maturity

    What's "yield to maturity"?

    YTM on a 10-Year, 9% Annual Coupon Bond

    Find r

    Finding our Rate?

    Find YTM if price were $1,134.20.

    YTM on Coupon Bond

    YTM on a Coupon Bond (Example)

    Using Short cut method

    Current Yield

    Bond Prices Immediately After a Coupon Payment

    Effect of Time on Bond Price

    Class Problem (Description)

    Class Problem (Description)

    Class Exercise (Description)

    Exercise for Practice (Description)

    Callable Bonds and Yield to Call

    Nominal Yield to Call (YTC)

    What Factors Affect Default Risk and Bond Ratings

    Other Factors That Affect Bond Ratings

    What Is Reinvestment Rate Risk

    What is reinvestment rate risk

    Term Structure Yield Curve

    Term Structure of Interest Rates

    Bond Prices (Why they change)

    Determining the Discount or Premium of a Coupon Bond

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    Bonds and Bonds Valuation PDF

    Description

    Test your knowledge on key concepts related to bonds, including coverage ratios, interest rates, and default risks. This quiz covers various aspects of bond features such as coupon rates, par value, and yield to maturity. Perfect for finance students looking to deepen their understanding of bonds.

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