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 (B)</p> Signup and view all the answers

Which of the following factors does NOT affect bond ratings?

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

What is the par value of a bond?

<p>The face amount paid at maturity (A)</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 (D)</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 (D)</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 (B)</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 (D)</p> Signup and view all the answers

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

<p>Market capitalization (B)</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 (B)</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. (A)</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. (C)</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. (A)</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. (A)</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 (B)</p> Signup and view all the answers

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

<p>Coupon payment received periodically. (C)</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. (B)</p> Signup and view all the answers

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

<p>Discount bond. (B)</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. (D)</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. (B)</p> Signup and view all the answers

What is the formula for calculating capital gains yield?

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

What factors affect the default risk and bond ratings?

<p>Issuer's financial health and market conditions. (D)</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. (D)</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. (C)</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. (C)</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. (D)</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. (C)</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. (A)</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 (B)</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. (D)</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. (C)</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. (A)</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% (C)</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. (D)</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. (A)</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. (B)</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] (A)</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. (B)</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) (C)</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% (B)</p> Signup and view all the answers

Flashcards

Par Value (Bond)

The face value of a bond, which is the amount the issuer will repay to the bondholder at maturity.

Coupon Interest Rate

The stated interest rate on a bond, which is multiplied by the par value to calculate the annual dollar amount of interest paid to the bondholder.

Maturity Date

The date on which the bond issuer must repay the par value to the bondholder.

Default Risk

The risk that the bond issuer will default on payments, either interest or principal, or both. This risk is higher for bonds issued by companies or governments with lower credit ratings.

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Call Provision

A provision that allows the bond issuer to repurchase the bond before its maturity date, typically at a pre-determined price. This is often done if interest rates have declined since the bond was issued, allowing the issuer to refinance at a lower rate.

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Yield to Maturity (YTM)

The annual rate of return earned by an investor on a bond, taking into account both the interest payments received and the difference between the bond's purchase price and its par value.

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Municipal Bonds

Bonds issued by municipalities or local governments, often used to finance public projects such as schools, hospitals, or roads. They typically offer tax advantages to investors.

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Bond Discount/Premium

The difference between the actual price paid for a bond and its par value, expressed as a percentage of the par value. A discount bond has a price lower than its par value, while a premium bond has a price higher than its par value.

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Zero-Coupon Bond

A bond that doesn't make periodic interest payments (coupons), instead, it is sold at a significant discount to its face value, and the entire interest payment is made at maturity.

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Zero-Coupon Yield

The difference between the price of a zero-coupon bond and its face value, representing the implied annualized return.

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Zero-Coupon Yield Curve

A graphical representation that shows the yields to maturity (YTM) for different maturities of zero-coupon bonds, indicating the market's expectations of future interest rates.

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Bond Pricing

The process of calculating the price of a bond based on its promised cash flows and the prevailing market interest rates.

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Coupon Rate

The annual interest rate that an issuer promises to pay the bondholder.

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Face Value

The face value of a bond, which is the amount the issuer will pay the bondholder at maturity.

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Coupon Payments

The regular interest payments made to the bondholder throughout the bond's life.

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Price of a Coupon Bond

The price of a coupon bond is determined by the present value of its future cash flows, including coupon payments and the face value at maturity.

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Market Interest Rate (r)

The market interest rate (r) is the discount rate used to calculate the present value of the bond's future cash flows.

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Coupon Payment (C)

The coupon payment (C) is the periodic interest payment made by the bond issuer to the bondholder.

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Number of Years to Maturity (n)

The number of years until the bond matures (n) determines the total number of coupon payments the bondholder will receive.

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Face Value (FV)

The face value (FV) of the bond is the amount the bond issuer promises to pay the bondholder at maturity.

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Bond Price and Interest Rate

When the market interest rate (r) increases, the present value of future cash flows decreases, resulting in a lower bond price.

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Premium Bond

If a bond's coupon rate exceeds the market interest rate (r), then the bond's price is likely to be above par, or at a premium.

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Discount Bond

If a bond's coupon rate is lower than the market interest rate (r), then the bond's price is likely to be below par, or at a discount.

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Years to Maturity (t)

The number of years remaining until the bond matures.

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Present Value (PV)

The price at which a bond is currently bought or sold in the market.

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Bond Trading at a Premium

When the bond's price is higher than its par value.

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Bond Trading at a Discount

When the bond's price is lower than its par value.

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Bond Trading at Par

When the bond's price is equal to its par value.

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Current Yield

The annual rate of return earned by an investor on a bond, considering only the interest payments received and the current price.

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Capital Gains Yield

The difference between the bond's purchase price and par value at maturity, expressed as a percentage of the par value.

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Reinvestment Rate Risk

The risk that future cash flows from an investment will have to be reinvested at lower interest rates, resulting in a lower overall return.

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Term Structure of Interest Rates

The relationship between interest rates and the maturity of bonds. It can be visualized as the yield curve.

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Yield Curve

A graphical representation of the term structure of interest rates, showing yields for bonds of different maturities.

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Sinking Fund Provision

A bond contract provision that requires the issuer to set aside funds to repay the bond at maturity.

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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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