Finance Ch 8

Front 1

Bond Theorem 1

Back 1

Bond prices are negatively related to interest rate movements-as interest rates rise bond prices fall and vice-versa

Front 2

Bond Theorem 2

Back 2

For a given change in interest rates, the prices of long-term bonds will change more than the prices of short term bonds-long term bonds have greater price volatility than short term bonds

Front 3

Bond Theorem 3

Back 3

For a given change in interest rates, the prices of lower-coupon bonds change more than the prices of higher coupon bonds-

Front 4

Bond Theorem applications

Back 4

as interest rates decline, the price of long-term zero coupon bonds will increase more than any other type of bonds

Front 5

True(intrinsic) value

Back 5

for a security, the value of the cash flows an investor who owns that security can expect to receive in the future

Front 6

Efficient capital market

Back 6

market where prices reflect the knowledge and expectations of all investors.

Front 7

Market operational efficiency

Back 7

the degree to which the transaction costs of bringing buyers and sellers together are minimized

Front 8

Transaction costs

Back 8

the cost of broker commissions, fees and expenses.

Front 9

Why is Market Operational Efficiency important?

Back 9

if transaction costs are high, market prices will be more volatile, fewer transactions will take place, and prices will not reflect the knowledge and expectations of investors as accurately

Front 10

informational efficiency

Back 10

the degree to which current market prices reflect relevant information and, therefore, the true value of the security

Front 11

Strong-form efficiency

Back 11

theory that security prices reflect all available information- few people believe this otherwise we wouldn't have things like insider trading

Front 12

Semistrong-form efficiency

Back 12

theory that security prices reflect all public information but not all private information. This is the one WE are

Front 13

Weak-form efficiency

Back 13

security prices reflect all information in past prices but do not reflect all private or public information.

Front 14

Vanilla Bonds

Back 14

most common bonds issued by corporations, have coupon payments that are fixed for life, at maturity, the entire original principal is paid and the bond retired

Front 15

Coupon payments

Back 15

the interest payments made to bondholders

Front 16

Face value/ par value

Back 16

amount on which interest is calculated and that is owed to the bondholder when a bond reaches maturity

Front 17

Coupon rate.

Back 17

the annual coupon payment divided by the bond's face value

Front 18

Zero coupon bonds

Back 18

bonds that have no coupons but promise a single payment at maturity, sold at a price well below their face value, most frequent is US Dept of Treasury

Front 19

Convertible Bonds

Back 19

corporate bonds can be converted into shares of common stock at some predetermined ratio at the discretion of bondholder- set so that the stock must at least rise 15-20 percent before it becomes profitable to convert the bonds. Pay a premium for these type of bonds.

Front 20

Bond Valuation

Back 20

1. estimate expected future cash flows 2. determine the required rate of return, or discount rate. Rate depends on riskiness. 3. Compute the discounted present value of the future cash flows. What an asset is worth at a particular point in time.

Front 21

Par value bonds

Back 21

bonds that sell at face value-whenever coupon rate is equal to market rate of interest

Front 22

Discount bonds

Back 22

bonds that sell below face value-coupon rate is lower than market rate

Front 23

Premium bonds

Back 23

bonds that sell above face value-the coupon rate is higher than market rate

Front 24

Yield to maturity

Back 24

the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond-"the promised yield"

Front 25

Effective annual yield

Back 25

annual yield that takes compounding into account: another name for EAR

Front 26

Realized Yield

Back 26

the interest rate at which the present value of the actual cash flows generated by a bond equals the bond's price- when an investor sells the bond before it's maturity date, it's the money he sold it for

Front 27

Marketability

Back 27

the ease with which an investor can sell a security quickly at a low transaction cost

Front 28

Call provision

Back 28

gives the issuing firm the right to purchase the bond from an investor at a pre-determined price and investor must sell. Sell at higher market yields because it's better for the person issuing the bond

Front 29

Default risk premium

Back 29

a premium that must be paid to investors when they purchase a security that exposes them to risk. Includes: compensation for expected loss is default occurs and 2. compensation for bearing the risk that default could occur

Front 30

Investment-grade bonds

Back 30

bonds with low risk of default that are rated Baa (BBB) or above

Front 31

Bond Ratings (moody's) (S&P)

Back 31

the highest grade bonds, those with the lowest default risk Aaa(AAA)

Front 32

Noninvestment-grade bonds or Junk Bonds

Back 32

anything below Baa (BBB)

Front 33

Term structure of interest rate

Back 33

the relation between yield and term to maturity

Front 34

Yield Curves

Back 34

the shape or slope of yield is not constant over time. Yield curves that are downward sloping means that yields are higher for shorter-term securities than for longer term. Upward sloping yields are higher for longer-term sercurities

Front 35

Which one of the following statements is NOT true

Back 35

Strong-form market efficiency implies that investors who have access to inside or private information will be able to earn abnormal returns

Front 36

Which ONE of the following statements is true?

Back 36

The largest investors in corporate bonds are life insurance companies and pension funds. The market for corporate bonds is thin. Prices in the corporate bond market also tend to be more volatile

Front 37

Zero coupon bonds...

Back 37

Zero coupon bonds have no coupon payments over its life and only offer a single payment at maturity. Zero coupon bonds sell well below their face value (at a deep discount) because they offer no coupon. The most frequent and regular issuer of zero coupon securities is the U.S. Treasury Department

Front 38

Bonds sell at a discount off the par value when market rates for similar bonds are

Back 38

greater than the bond's coupon rate.

Front 39

The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments

Back 39

equal to the price of the bond.

Front 40

As interest rates increase,...

Back 40

bond prices increase

Front 41

Nathan Akpan is planning to invest in a seven-year bond that pays annual coupons at a rate of 7 percent. It is currently selling at $927.23. What is the current market yield on such bonds? (Round to the closest answer.)

Back 41

8.4%

Front 42

Alice Trang is planning to buy a six-year bond that pays a coupon of 10 percent semiannually. Given the current price of $878.21, what is the yield to maturity on these bonds?

Back 42

2 $50 - $878.21 $1,000= 13%

Front 43

If John buys a 5-year bond with a 9% coupon rate (paid semi-annually) and $1000 par value for $925, his yield to maturity would be closest to

Back 43

10.99%. Remember to multiply at the end

Front 44

A bond with a $1,000 face value and an 8 percent annual coupon pays interest semiannually. The bond will mature in 15 years. The yield to maturity is 11 percent. What is the price of the bond today?

Back 44

$781.99

Front 45

Generic Inc. has bonds that were issued in 1988 and will mature in 16 years. The bonds pay a 14.375% coupon and the interest is paid semiannually. The current price is $1,508.72. What is the yield to maturity on the bonds?

Back 45

8.5%

Front 46

A benefit of a convertible bond is

Back 46

companies can offer a lower interest rate and attract investors.

Front 47

A bond will sell at a premium when

Back 47

the coupon interest rate exceeds the market interest rate on similar bonds

Front 48

A bond that pays a coupon interest rate of 7.5% at a time when the yield is 8.4% will be selling at a _____. If that bond pays interest annually, its price will be _____ than if the bond pays interest semiannually.

Back 48

discount; higher