Questions and Answers
The current yield on a bond is equal to the annual interest divided by the:
Which statement is true?
If inflation is expected to steadily decrease in the future, the term structure of interest rates will most likely be:
A semiannual 5.4 percent coupon bond currently sells for par value. What is the maturity on this bond?
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Bond ratings classify bonds based on:
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An agent who buys and sells securities from inventory is called a:
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Which one of the following must equal zero if a firm pays a constant annual dividend?
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Dividends are:
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Which one of the following statements is correct?
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The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to:
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The internal rate of return is the:
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What condition must exist if a bond's coupon rate is to equal both the bond's current yield and its yield to maturity? Assume the market rate of interest for this bond is positive.
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Which one of the following terms applies to a bond that initially sells at a deep discount and only makes one payment to bondholders?
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The term structure of interest rates represents the relationship between which of the following?
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Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected?
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When a bond's yield to maturity is less than the bond's coupon rate, the bond:
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Which one of the following statements is true?
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All else held constant, the price of a bond increases when the:
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Which one of the following bonds is the most sensitive to changes in market interest rates?
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An unexpected decrease in market interest rates will cause a:
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Study Notes
Bond Fundamentals
- Current yield on a bond is calculated using annual interest divided by current market price.
- True statement regarding bonds: An indenture is a formal agreement between the bond issuer and bondholders.
- If inflation decreases, the term structure of interest rates is likely to be downward sloping.
Bond Characteristics
- A semiannual 5.4% coupon bond can have any maturity date if currently selling at par value.
- Bond ratings primarily assess default risk among various categories.
- A dealer is an agent who actively buys and sells securities from inventory.
Dividends and Returns
- If a firm pays a constant annual dividend, the capital gains yield must equal zero.
- Dividends paid by firms come from after-tax profits, not tax-deductible expenses.
- Payback period ignores time value of money, evaluating projects primarily on cash flow recovery time.
Financial Metrics
- Internal rate of return (IRR) is defined as the discount rate that makes the net present value (NPV) of a project equal to zero.
- For coupon bonds, when the market price equals par, the coupon rate matches both current yield and yield to maturity.
Bond Types
- A zero coupon bond sells at a deep discount, providing a single payment at maturity.
- The term structure of interest rates relates nominal rates on default-free bonds to their time to maturity.
- Additional compensation to bondholders to mitigate default risks is known as the default risk premium.
Market Sensitivity
- Bonds with coupon rates lower than the current yield are selling at a premium.
- A bond’s price increases when the yield to maturity decreases, indicating inverse relationship dynamics.
- 10-year zero coupon bonds are most sensitive to changes in market interest rates due to longer duration without cash flows.
Interest Rate Impact
- An unexpected drop in market interest rates will decrease yields to maturity for coupon bonds and impact zero coupon bond prices.
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Test your knowledge with these finance flashcards focused on bond yields and related concepts. Each card presents a question and multiple-choice answers to gauge your understanding of key finance principles. Perfect for exam preparation!