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Questions and Answers
What happens to the coupon payments received from bonds during the holding period?
What happens to the coupon payments received from bonds during the holding period?
Which factor is directly linked to calculating the present value of a bond?
Which factor is directly linked to calculating the present value of a bond?
What is default risk in the context of bond investing?
What is default risk in the context of bond investing?
What typically reflects the likelihood that bond issuers will repay their debt?
What typically reflects the likelihood that bond issuers will repay their debt?
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What is a long-term capital gain from holding bonds until maturity?
What is a long-term capital gain from holding bonds until maturity?
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What is the par value of a bond?
What is the par value of a bond?
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Which type of bond allows the issuer to repurchase the bond before maturity?
Which type of bond allows the issuer to repurchase the bond before maturity?
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What typically affects the yield from investing in a bond?
What typically affects the yield from investing in a bond?
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Which characteristic of a convertible bond is true?
Which characteristic of a convertible bond is true?
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What is a common characteristic of bonds that have a call feature?
What is a common characteristic of bonds that have a call feature?
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How do bonds fit into a financial plan?
How do bonds fit into a financial plan?
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What is one reason why some bonds are considered risky?
What is one reason why some bonds are considered risky?
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What is a characteristic of zero-coupon bonds?
What is a characteristic of zero-coupon bonds?
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What is the relationship between bond risk ratings and risk premiums?
What is the relationship between bond risk ratings and risk premiums?
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How does the economic condition affect the risk of default on bonds?
How does the economic condition affect the risk of default on bonds?
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What type of risk is associated with a callable bond being redeemed by the issuer?
What type of risk is associated with a callable bond being redeemed by the issuer?
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What happens to the yield to maturity of a bond if it sells above par value?
What happens to the yield to maturity of a bond if it sells above par value?
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Which tax benefits do Treasury bonds offer?
Which tax benefits do Treasury bonds offer?
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Which bond rating class indicates the lowest quality?
Which bond rating class indicates the lowest quality?
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Which type of bond is typically issued by large, stable firms?
Which type of bond is typically issued by large, stable firms?
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How does bond maturity affect interest rate risk?
How does bond maturity affect interest rate risk?
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What is the primary risk associated with high-yield (junk) bonds?
What is the primary risk associated with high-yield (junk) bonds?
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What happens to the value of a bond when interest rates rise?
What happens to the value of a bond when interest rates rise?
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What typically happens to a bond's price when interest rates rise?
What typically happens to a bond's price when interest rates rise?
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What aspect of bond trading is affected by changes in interest rates?
What aspect of bond trading is affected by changes in interest rates?
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How is interest earned from bonds taxed?
How is interest earned from bonds taxed?
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What risk often arises when a company faces financial difficulties?
What risk often arises when a company faces financial difficulties?
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Which of the following is NOT a typical aspect of corporate bond quotations?
Which of the following is NOT a typical aspect of corporate bond quotations?
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Which of the following is true regarding a bond with a rating of 'BBB'?
Which of the following is true regarding a bond with a rating of 'BBB'?
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If a bond is sold at a higher price than its purchase price, what is the result?
If a bond is sold at a higher price than its purchase price, what is the result?
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If a bond sells below par value, what can be inferred about its yield to maturity?
If a bond sells below par value, what can be inferred about its yield to maturity?
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What is the coupon payment from bonds paying a coupon rate of 8% on a par value of $10,000?
What is the coupon payment from bonds paying a coupon rate of 8% on a par value of $10,000?
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What tax applies to gains earned from selling bonds held longer than a year?
What tax applies to gains earned from selling bonds held longer than a year?
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Which feature makes Treasury bonds appealing to investors?
Which feature makes Treasury bonds appealing to investors?
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What impact do falling interest rates have on the value of bonds?
What impact do falling interest rates have on the value of bonds?
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If a bondholder sells their bonds after eight months, what type of tax implications might they encounter?
If a bondholder sells their bonds after eight months, what type of tax implications might they encounter?
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What is the coupon payment received every six months for bonds with a total coupon of $800 per year?
What is the coupon payment received every six months for bonds with a total coupon of $800 per year?
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What is a key consideration when selecting the maturity of a bond?
What is a key consideration when selecting the maturity of a bond?
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What type of strategy involves purchasing long-term bonds when expecting interest rates to fall?
What type of strategy involves purchasing long-term bonds when expecting interest rates to fall?
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What describes a passive bond investment strategy?
What describes a passive bond investment strategy?
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How does the maturity matching strategy aid investors?
How does the maturity matching strategy aid investors?
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Which of the following indicates a challenge of the interest rate strategy?
Which of the following indicates a challenge of the interest rate strategy?
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What should investors do if they find it difficult to forecast interest rates?
What should investors do if they find it difficult to forecast interest rates?
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For a parent aiming to cover a future education expense, which bond investment strategy is most suitable?
For a parent aiming to cover a future education expense, which bond investment strategy is most suitable?
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What is the primary objective of determining whether to invest in bonds?
What is the primary objective of determining whether to invest in bonds?
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Study Notes
Chapter 16: Investing in Bonds
- Bonds are long-term debt securities issued by government agencies or corporations.
- Par value is the face value of a bond, the amount returned to the investor at maturity.
- Most bonds have maturities between 10-30 years.
- Bond issuers are required to make interest payments and repay par value.
Bond Characteristics
- Call feature: allows the issuer to repurchase the bond from the investor before maturity. These bonds offer a slightly higher return.
- Convertible bond: a bond that can be converted into a stated number of shares of the issuer's stock if the stock price reaches a specified price. These bonds tend to offer a slightly lower return.
Bond Yield to Maturity
- Bond's yield to maturity is the annualized return on a bond if it is held until maturity.
- If a bond sells at par value, its yield to maturity equals the coupon rate.
- If a bond sells below par value, its yield to maturity would exceed the coupon rate.
- If a bond sells above par value, its yield to maturity would be less than the coupon rate.
Bond Trading in the Secondary Market
- Investors can sell their bonds to other investors before maturity.
- Bond prices change in response to interest rates.
- Brokerage firms facilitate bond trading.
Types of Bonds
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Treasury bonds: long-term debt securities issued by the U.S. Treasury. Payments are guaranteed by the federal government. Interest is subject to federal income tax, but exempt from state and local taxes. Easily traded in the secondary market.
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Corporate bonds: long-term debt securities issued by large firms. Subject to default risk. High-yield (junk) bonds are issued by smaller, less stable corporations with a higher degree of default risk.
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Corporate bond quotations: include coupon rate, maturity date, current yield, volume, closing price, and net change compared to the previous day.
Return from Investing in Bonds
- Interest rate movements impact bond returns: rising rates decrease bond value; falling rates increase bond value.
- Tax implications: interest is taxed as ordinary income (unless exempt); selling bonds above purchase price results in a capital gain.
Valuing a Bond
- Time value of money is used to determine bond value (present value of future coupon payments and principal payment).
- Economic conditions can affect bond values. Healthy firms are more likely to make payments, which is crucial to sustaining high bond return.
Risk from Investing in Bonds
- Default risk: risk that a borrower won't repay the loan: risk premium is the extra yield investors need to be compensated for the risk of default. Risk ratings assess default risk (e.g, AAA, BBB, etc.) from agencies like Moody's and Standard & Poor's.
- Impact of financial crisis: firms may have trouble meeting their bond payment obligations in unfavorable economic conditions.
- Call (prepayment) risk: the risk that a callable bond will be redeemed by the issuer before its maturity, hence the risk of missing out on expected returns.
- Interest rate risk: the risk of a bond's price declining due to rising interest rates; affects bonds with longer maturities more.
Bond Investment Strategies
- Interest rate strategy: selecting bonds based on interest rate expectations. Purchase long-term bonds if you expect rates to fall.
- Passive strategy: invest in a diversified portfolio of bonds held for a long time.
- Maturity matching strategy: investment in bonds that have maturities aligning with future expenses, e.g., college tuition.
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Description
This quiz covers the essential concepts related to investing in bonds, including bond characteristics, par value, and yield to maturity. Understand different types of bonds such as callable and convertible bonds, and how they impact investment decisions. Test your knowledge of bond investments and their features.
