Bond Valuation and Cash Flow Analysis
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Questions and Answers

What does the present value of a bond's income stream represent?

  • Only the par value of the bond
  • The sum of future cash flows without discounts
  • The total future cash flows discounted back to present (correct)
  • The total interest rate applied over the bond's lifetime

    • How many total coupon payments are there for a four-year, semi-annual bond with 9% interest?

  • 8 (correct)
  • 4
  • 6
  • 10

    • What is the total value of the eight coupon payments from the bond?

  • $40
  • $20
  • $32
  • $36 (correct)

    • What does a negative present value (-29.0845) indicate in bond calculations?

    <p>The cost of receiving future coupon payments</p> Signup and view all the answers

    Which button is generally used on financial calculators to calculate present value?

    <p>CPT</p> Signup and view all the answers

    What does the 'I/Y' key represent in bond calculations?

    <p>Percentage yield of the investment</p> Signup and view all the answers

    When calculating the present value of the coupon payments, which input represents the cash flows?

    <p>The coupon payment amount</p> Signup and view all the answers

    Which formula can be used to find the present value of the bond’s principal?

    <p>PV = FV / (1 + r)^n</p> Signup and view all the answers

    What is the implication of a positive present value in bond assessments?

    <p>It indicates an incoming cash flow</p> Signup and view all the answers

    How can investors analyze the value of future cash inflows from a bond?

    <p>Calculating their present value</p> Signup and view all the answers

    What is the total number of cash flows received by a bondholder over the life of the four-year, semi-annual bond?

    <p>8</p> Signup and view all the answers

    What method is used to calculate the present value of a bond?

    <p>Discounting future cash flows</p> Signup and view all the answers

    How is the present value calculated for each coupon payment of the bond?

    <p>Dividing the future amount by (1 + interest rate) raised to the power of the payment number</p> Signup and view all the answers

    What is the interest rate used for discounting in this bond example?

    <p>5%</p> Signup and view all the answers

    Which of the following is true regarding the cash flow received at maturity for this bond?

    <p>The final coupon payment and the principal are returned</p> Signup and view all the answers

    What is the value of (1 + 0.05)^8 as calculated using a financial calculator?

    <p>1.4775</p> Signup and view all the answers

    If the bond has a maturity value of $100, what is the correct formula to find its present value?

    <p>PV = sum of cash flows divided by (1 + interest rate)^8</p> Signup and view all the answers

    Which of the following correctly describes the role of the financial calculator in bond valuation?

    <p>It quickly and precisely carries out discounting calculations</p> Signup and view all the answers

    What does the acronym C1 through C8 refer to in the cash flow timeline for the bond?

    <p>The individual coupon payments received semi-annually</p> Signup and view all the answers

    What is more significant in determining the impact on bond prices when interest rates change?

    <p>Relative yield change</p> Signup and view all the answers

    How does the price of a bond react when there is a decrease in yield compared to an increase in yield of the same percentage?

    <p>Price increases by a larger percentage with a yield decrease.</p> Signup and view all the answers

    At what yield levels are bond prices considered to be more volatile?

    <p>When yields are low</p> Signup and view all the answers

    Given a drop in yield from 12% to 10%, how does this compare in impact to a drop from 4% to 2%?

    <p>The drop from 4% to 2% has a greater impact.</p> Signup and view all the answers

    What is the price change percentage resulting from a 1% increase in yield based on the given table?

    <p>-4.49%</p> Signup and view all the answers

    What is the formula used to calculate the present value of a bond's principal cash flow?

    <p>$PV = FV / (1 + r)^n$</p> Signup and view all the answers

    Which of the following best describes the relationship between interest rates and bond prices?

    <p>Bond prices change in the opposite direction to interest rates.</p> Signup and view all the answers

    If a coupon payment of $4.50 is made semi-annually at a rate of 5%, what is the present value of the first coupon payment?

    <p>$4.29$</p> Signup and view all the answers

    How is the present value of the coupon payments for the second period calculated in the example?

    <p>$4.50 / (1 + 0.05)^2$</p> Signup and view all the answers

    What is the total present value of the income stream from the bond after calculating all coupon payments?

    <p>$29.08$</p> Signup and view all the answers

    What total amount is subtracted from the first coupon payment to check its correctness?

    <p>$5%$</p> Signup and view all the answers

    What is the present value of the coupon payment expected to be received in two years?

    <p>$3.89$</p> Signup and view all the answers

    Which statement correctly describes the present value calculation process for multiple cash flows?

    <p>Each cash flow is discounted back to the present and then summed.</p> Signup and view all the answers

    In the provided example, what is the par value of the bond used to demonstrate present value calculations?

    <p>$100$</p> Signup and view all the answers

    What financial concept does the calculation of the present value of a bond primarily illustrate?

    <p>Time value of money</p> Signup and view all the answers

    How often are coupon payments made for the bond in the example?

    <p>Semi-annually</p> Signup and view all the answers

    Which bond is likely to experience a greater price increase when yields decrease to 2%?

    <p>3% five-year bond</p> Signup and view all the answers

    What happens to the volatility of a bond as it approaches maturity?

    <p>Volatility decreases.</p> Signup and view all the answers

    By how much does the price of the 3% bond change when yields increase to 4%?

    <p>−4.49%</p> Signup and view all the answers

    Which of the following statements about lower coupon bonds is true?

    <p>They exhibit greater price volatility.</p> Signup and view all the answers

    If market rates originally start at 3%, what is the initial price of a 2% five-year bond?

    <p>95.39</p> Signup and view all the answers

    When yields decrease, how does the price of the 2% bond respond?

    <p>Increases by 4.83%</p> Signup and view all the answers

    What is the price change percentage for the 2% bond when yields increase to 4%?

    <p>−4.58%</p> Signup and view all the answers

    After how many years will a bond originally with a 10-year maturity be traded as a three-year bond?

    <p>7 years</p> Signup and view all the answers

    Given a market rate increase, which bond will fall less in price?

    <p>3% bond</p> Signup and view all the answers

    A bond typically becomes less volatile as it approaches its maturity due to what primary reason?

    <p>It has a shorter time until redemption.</p> Signup and view all the answers

    Study Notes

    Cash Flow Timeline of a 9% Bond

    • Coupon payments: Made semi-annually at $4.50 for a four-year bond.
    • At maturity (end of Year 4), bondholder receives final coupon payment and return of principal ($100).

    Present Value Calculations

    • Present value (PV) determines the current worth of future cash flows by discounting them.
    • Formula: ( PV = \frac{C}{(1 + r)^n} )
      • ( C ) = cash flow (coupon or principal)
      • ( r ) = discount rate (interest rate)
      • ( n ) = number of compounding periods

    Present Value of Income Stream

    • Total of eight semi-annual coupon payments worth $36 ($4.50 each).
    • Present value of the income stream calculated as the sum of individual present values of coupon payments.
    • Financial calculator steps for PV of income stream:
      • Input 8 (N), 5 (I/Y), 4.50 (PMT), 0 (FV)
      • Result: PV of income stream is approximately -$29.08

    Present Value of Principal

    • Calculation for principal's present value:
      • FV = $100 (principal)
      • Input 8 (N), 5 (I/Y)
      • Result: Present value of principal is approximately $67.68

    Impact of Coupon Rates

    • Lower-coupon bonds exhibit greater price volatility compared to higher-coupon bonds.
    • Price sensitivity is evident when market interest rates fluctuate.

    Effect of Interest Rate Changes

    • Bonds with higher coupons experience smaller price changes when yields rise or fall.
    • Example of a 3% and a 2% five-year bond shows differing price changes for the same yield shift.

    Relative vs Absolute Yield Change

    • Relative yield change affects bond prices more significantly than absolute changes.
    • A yield drop from 4% to 2% (50% change) impacts price more than from 12% to 10% (17% change).

    Price Volatility and Duration

    • Bond prices inversely correlate to interest rate changes: increasing rates lower prices, and decreasing rates raise prices.
    • Duration measures bond price volatility, indicating sensitivity to interest rate shifts.

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    Description

    This quiz covers the cash flow timeline for a four-year, semi-annual bond with a 9% interest rate. Participants will explore present value concepts, coupon payments, and the total return upon maturity. Ideal for students studying finance or investment analysis.

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