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Questions and Answers
What is the primary characteristic that differentiates convertible bonds from nonconvertible ones?
What is the primary characteristic that differentiates convertible bonds from nonconvertible ones?
Under what condition is it more profitable for bondholders to convert their convertible bonds into shares?
Under what condition is it more profitable for bondholders to convert their convertible bonds into shares?
What do puttable bonds allow bondholders to do?
What do puttable bonds allow bondholders to do?
What is a significant risk associated with floating-rate bonds?
What is a significant risk associated with floating-rate bonds?
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How do preferred stockholders rank compared to common stockholders and bondholders when it comes to dividend distribution?
How do preferred stockholders rank compared to common stockholders and bondholders when it comes to dividend distribution?
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What happens if a company fails to pay preferred stock dividends?
What happens if a company fails to pay preferred stock dividends?
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What describes the market conversion value of a convertible bond?
What describes the market conversion value of a convertible bond?
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Which of the following is an advantage of floating-rate bonds?
Which of the following is an advantage of floating-rate bonds?
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What does the current yield of a bond consider?
What does the current yield of a bond consider?
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Which of the following is NOT a limitation of the Holding Period Return (HPR)?
Which of the following is NOT a limitation of the Holding Period Return (HPR)?
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How is Yield to Maturity (YTM) best defined?
How is Yield to Maturity (YTM) best defined?
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What key factor does Yield to Maturity assume regarding coupon payments?
What key factor does Yield to Maturity assume regarding coupon payments?
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What is a major drawback of calculating Yield to Maturity?
What is a major drawback of calculating Yield to Maturity?
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What is the primary factor affecting the Yield to Maturity (YTM) of a bond?
What is the primary factor affecting the Yield to Maturity (YTM) of a bond?
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When a bond's current yield is greater than its YTM, what does this indicate about the bond's price relative to par value?
When a bond's current yield is greater than its YTM, what does this indicate about the bond's price relative to par value?
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What is one primary feature of callable bonds?
What is one primary feature of callable bonds?
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What happens to a premium bond if held to maturity?
What happens to a premium bond if held to maturity?
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What does the term 'discount bond' refer to?
What does the term 'discount bond' refer to?
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Which characteristic distinguishes convertible bonds from other bond types?
Which characteristic distinguishes convertible bonds from other bond types?
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Why might a company choose to issue callable bonds?
Why might a company choose to issue callable bonds?
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Which statement best describes the holding period return?
Which statement best describes the holding period return?
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What is a key reason bond prices move towards par value as maturity approaches?
What is a key reason bond prices move towards par value as maturity approaches?
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What type of bonds are tax-free at the interest payment level?
What type of bonds are tax-free at the interest payment level?
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In a competitive market, what must bonds of the same maturity and risk profile provide?
In a competitive market, what must bonds of the same maturity and risk profile provide?
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Which company issued a bond with a 100-year maturity that can be redeemed in 30 years?
Which company issued a bond with a 100-year maturity that can be redeemed in 30 years?
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If a bond has 60 semi-annual coupon payments remaining, how can we determine its interest rate?
If a bond has 60 semi-annual coupon payments remaining, how can we determine its interest rate?
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Which of these statements about bonds is true?
Which of these statements about bonds is true?
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What is the conversion ratio in convertible bonds?
What is the conversion ratio in convertible bonds?
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What is a major drawback for investors when bonds are called?
What is a major drawback for investors when bonds are called?
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What happens to a bond's price that is currently trading at a premium as time passes?
What happens to a bond's price that is currently trading at a premium as time passes?
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What do zero-coupon bonds typically sell for before maturity?
What do zero-coupon bonds typically sell for before maturity?
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How is the price of a zero-coupon bond calculated?
How is the price of a zero-coupon bond calculated?
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Which property is NOT true for a list?
Which property is NOT true for a list?
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What is a characteristic of negative indexing in Python lists?
What is a characteristic of negative indexing in Python lists?
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What is the primary return for investors in zero-coupon bonds?
What is the primary return for investors in zero-coupon bonds?
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What does the variable 'r' represent in the zero-coupon bond pricing formula?
What does the variable 'r' represent in the zero-coupon bond pricing formula?
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Which statement about lists in Python is correct?
Which statement about lists in Python is correct?
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What components make up the discount rate used to compute present value in bond pricing?
What components make up the discount rate used to compute present value in bond pricing?
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If a bond has a coupon rate of 8% and pays coupons semi-annually, how much is each payment if its par value is $1,000?
If a bond has a coupon rate of 8% and pays coupons semi-annually, how much is each payment if its par value is $1,000?
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What is the bond price when the market interest rate equals the coupon rate?
What is the bond price when the market interest rate equals the coupon rate?
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In the formula for bond pricing, what does the term 'Coupon x Annuity factor(r,T)' represent?
In the formula for bond pricing, what does the term 'Coupon x Annuity factor(r,T)' represent?
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What is the appropriate formula to calculate the present value of the par value of a bond?
What is the appropriate formula to calculate the present value of the par value of a bond?
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How many total coupon payments are made for a bond with a maturity of 30 years and semi-annual payments?
How many total coupon payments are made for a bond with a maturity of 30 years and semi-annual payments?
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When annual market interest rate is 8% for a bond with an 8% coupon rate, what is the yield effect on the bond's market price?
When annual market interest rate is 8% for a bond with an 8% coupon rate, what is the yield effect on the bond's market price?
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What formula would you use to calculate the bond price when given the coupon payment and market interest rate?
What formula would you use to calculate the bond price when given the coupon payment and market interest rate?
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Study Notes
Bond Definitions and Terminology
- A bond is a security issued for borrowing arrangements.
- The borrower sells bonds to lenders for cash.
- The issuer agrees to make payments (coupons) to the bondholder.
- At maturity, the nominal value is repaid.
Bond Terminology
- Par value (face or nominal value): The payment to the bondholder at maturity.
- Coupon rate: The bond's interest payments relative to its par value.
- Bond indenture: The contract between the issuer and bondholder.
- Accrued interest: The prorated share of an upcoming coupon payment when a bond is purchased between coupon payments.
Bond Coupons
- A bond with a par value of $1,000 and an 8% coupon rate may sell for $1,000.
- The bondholder is entitled to 8% of the par value (or $80 per year) for the bond's life.
- Payments are usually in two semi-annual installments.
- At maturity, the issuer repays the par value ($1,000).
Bonds as a Form of Debt
- Bonds are a form of debt.
- Interest payments are tax-deductible for firms.
- Issuers are borrowers, while bond buyers are lenders.
- Bonds offer borrowers access to a larger pool of lenders, which leads to better pricing.
- Bonds can easily be traded in the secondary market.
- Bonds have more standardized payment structures compared to bank loans.
Bond Prices
- Bonds are often issued at par (the price equals the par value).
- Zero-coupon bonds are sold at a discount.
- Bond prices depend on market conditions after issuance.
Accrued Interest Example
- Suppose an 8% bond with $40 semi-annual coupon payments has 30 days since the last coupon payment.
- The accrued interest would be $6.59.
- Invoice price = flat price + accrued interest
How Bonds are Traded
- Primary market issuance: Governments and corporations issue bonds to raise capital.
- Secondary market trading: Bonds are typically traded among investors in the over-the-counter (OTC) market after initial issuance.
- Dealers buy and sell bonds from their own inventory, providing liquidity to the market.
- Many bonds are traded OTC, rather than formal exchanges.
Bond Types by Issuer
- Government bonds (US Treasury notes and bonds; other countries have similar bond types.): Government bonds are generally considered safe investments because they are backed by the government.
- Agency bonds: Issued by government agencies or mortgage-related agencies.
- Municipal bonds: Issued by local government institutions; interest payments are often tax-free.
- Corporate bonds: Issued by corporations; Maturity duration is usually a range from 7 to 30 years, but there are also longer term options.
Bond Types by Characteristics
- Callable bonds: Allow the issuer to repurchase the bond at a specific call price before the maturity date.
- Convertible bonds: Allow the bondholder to exchange a bond for a specified number of the firm's shares.
- Puttable bonds: Give bondholders the option to exchange the bond for its par value at a specified date or to extend the bond's life.
- Floating-rate bonds: Adjust the interest rate periodically according to a prevailing market rate.
- Preferred stock: Considered an equity investment, but frequently included within fixed income, as it typically pays a fixed dividend.
International bonds
- Foreign bonds: Issued by a borrower from a country other than where the bond is sold. Denominated in the currency of the country where it's marketed.
- Eurobonds: Denominated in one currency, and sold in other national markets.
Innovation in the Bond Market
- Inverse floaters: Coupon rates move in the opposite direction of general interest rate movements.
- Asset-backed bonds: Income from a specified group of assets is used to service the debt.
- Catastrophe (CAT) bonds: A form of insurance securitization where investors receive higher coupon rates for taking on risk; bondholders lose all or part of their investment in the event of a catastrophe.
Indexed bonds
- Indexed bonds make payments tied to a general price index or a commodity's price.
- Examples include Treasury Inflation-Protected Securities (TIPS).
Credit Risk
- Credit risk (default risk): The risk that a bond will not repay all promised payments.
- Rating companies: Moody's, Standard & Poor's, and Fitch.
- Rating categories: AAA (or Aaa) to lower ratings (speculative-grade bonds or junk bonds)
- Determines of bond safety: Coverage ratios, leverage ratios, liquidity ratios, profitability ratios, and cash flow to debt ratios.
- Bond indentures: Set of restrictions (protective covenants) that safeguard bondholders from default. These may include sinking funds, subordination clauses, dividend limitations, and collateralization.
- Credit spread: The difference between the yield-to-maturity (YTM) of a corporate bond and the YTM of an otherwise identical government bond.
Bond Pricing
- Bond value is the present value of its cash flows.
- Discount rate encompasses the risk-free rate, expected inflation premium, and risk premium; it used to compute the present value.
- Bond pricing and the coupon rate and market interest rate relationship: Bonds sell at par if the coupon rate equals the market interest rate; if the coupon rate is lower, the bond sells at a discount; if higher, the bond sells at a premium.
Bond Profitability Measures
- Total bond return: The overall return from holding a bond over a period. It’s the sum of income component (periodic coupon payments) and capital gains or losses (difference between purchase and sale prices, or face value at maturity).
- Current yield: Annual coupon payment divided by the current bond price; simple measure of profitability, but ignores capital gains and losses.
- Holding period return (HPR): The rate of return over a particular holding period; depends on the bond’s price at the end of the period and is difficult to compare across different bonds with different holding periods and maturities; the rate of return is only forecastable.
- Yield to maturity (YTM): The interest rate that equates the present value of a bond's payments to its price; most commonly used measure of bond profitability; it assumes that coupon payments will be reinvested at the same yield.
Bond Prices Over Time
- Bond prices generally converge to par value at maturity.
- Premium bonds often have higher coupon payments but may result in capital losses if purchased above par and held to maturity.
- Discount bonds offer lower coupon payments, but the potential for capital gains as the price rises to maturity.
Zero-Coupon Bonds
- Zero-coupon bonds only pay a lump sum at maturity.
- US Treasury Bills are an example. Zero coupon's price falls during the time until maturity, owing to the time value of money.
Python Lists and For-Loops
- Lists: Ordered, modifiable collections of mixed datatypes.
- For-loops: Repeatedly execute a block of code for items in sequences or iterables (e.g., lists). They are used to automate repetitive tasks and are useful when dealing with a large number of items.
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Description
This quiz covers key concepts related to bonds and preferred stocks, including convertible and floating-rate bonds. Test your understanding of bondholder rights, risks, and financial calculations like Yield to Maturity. Perfect for finance students seeking to solidify their knowledge in investment securities.