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Read topics:
a. Kinds of Interest, Kind of Interest Rates
b. Bond Valuation
, Bond Valuation – Present Value of a Bond, Par Value, Coupon Payments, Indenture, Maturity Date, Market Interest Rate
Discussion 1 – Bonds
In chapter 6, we have discussed how to value bonds. If all investors are using this method, why does the same bond buy or sell at different prices? In other words, why is there a market for bonds? Why do some financial analysts treat preferred stock as a special type of bond rather than as an equity security? Include in your discussion the relationship between bond prices and interest rates.
Link: https://leocontent.umgc.edu/content/umuc/tus/finc/finc331/2228/modules/finc330/m2-
module-2/s3-commentary.html#I
UMGC Module 2: Financial Securities
Topics
The Time Value of Money
The Time Value of Money
Arguably, the time value of money concept is the most fundamental concept in the study of
finance. It basically states that a dollar received today is worth more than a dollar received
tomorrow. The underlying reason for this statement is that it is assumed that the dollar received
today can be invested and earn some interest before the dollar received tomorrow, whereas the
dollar to be received tomorrow obviously cannot earn interest today. Logically, this means a
dollar to be received in the future must somehow be discounted, or adjusted in value, to be
financially comparable to a dollar received in the present.
Extrapolating on this principal, logically, if we are to compare the expected return of alternative
projects, strategies, and investments over varying periods of time, we must first convert all the
dollars received at the various times in the future back to their present-day value. This process is
called present value.
Alternatively, we could achieve the same desired comparable results by moving all the dollars
received at various times out to some common future date. This process is called future value.
Only when the alternative investment cash flows are compared in dollar values of the same date
is the financial evaluation of alternative returns meaningful.
The Concept of Compound Interest and Future Value
Although most financial analysis is conducted from the perspective of present value, we will
begin our discussion of the time value of money concept with future value because it is easier to
understand. We start by considering the term compound interest. It occurs when the interest paid
on an investment during the first period is added to the principal, and during the second period
interest is earned on both the principal and the prior period interest.
There are three methods of calculating compound interest—longhand, equation, and financial
tables. Using the following scenario, we’ll go through each method. Consider $100 invested for
three years earning compounded interest at an annual rate of 6% per year.
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1. Longhand—This method can be tedious, especially if you’re calculating the compound
interest over 10 or 20 years.
Beginning of
year 1
= $100 = $100.00
End of year 1
(FV1)
= $100 + $100(.06) = $106.00
End of year 2
(FV2)
=
[$100 + $100(.06)] + [$100 + $100 (.06)] (.06)
or $106.00 + $106 (.06)
=
$112.36
$112.36
End of year 3
(FV3)
= $112.36 + $112.36 (.06) = $119.10
The above mathematical progression can be generalized into the following formula for
calculating the compound or future value (FV) on any present value (PV) amount given
these two variables, the discount rate per period (i) and the number of periods (n).
2. Compound interest or future value equation—This method is much cleaner and
quicker than the longhand method.
FVn = PV(1 + i)n
where:
FVn = future value at the end of n periods
PV = present value, or the original amount, deposited at the beginning of
period
n = number of periods of compounding = 3
i = interest rate per period = 6%
Please note that in the generalized formula, we specifically used the term periods and not
years because mathematically the general formula derived applies for any given period of
time (years, quarters, weeks, or days). Financially, we typically see compounding
annually, semiannually, or quarterly.
3. Financial tables—You can find these future value (compound sum of $1) tables at the
back of your textbook. They may make compounding interest easier than do the other
two methods.
Also note that the (1 + i)n factor in the tables will work for any amount PV. Simply
multiply the amount by the factor (l + i)n. Given this relationship, financial tables can be
constructed for all reasonable combinations of interest rate per period and number of
periods. We recommend that you look at financial tables for the compound sum of $1 for
various interest rates and periods.
If you check the table for the interest rate of 6% for years 1, 2, and 3, you will find the
following factors:
i = 6%, n = 1 —– = 1.060
i = 6%, n = 2 —– = 1.124
i = 6%, n = 3 —– = 1.191
Multiply these factors by the PV of $100, shown in our above-illustrated example, and you get
the following amounts, which, adjusted for rounding, match the solutions in our compounding
example:
i = 6%, n = 1 —– = 1.060 ($100) = $106.00
i = 6%, n = 2 —– = 1.124 ($100) = $112.40 *difference caused by rounding
i = 6%, n = 3 —– = 1.191 ($100) = $119.10
This example illustrates how the compounding formula developed for future value calculations is
used to construct the standard financial compounding tables found in all finance textbooks. The
compounding formula rewritten to allow easy use of the data in the compound financial tables is:
where FVIFi, n represents the appropriate financial table compounding factor for interest rate i
and periods n.
It is important for you to be able to solve future-value financial problems by financial calculator,
mathematical calculation, or financial tables. We recommend making the investment, in cash and
time, in a financial calculator. It is a significant time saver in this course and may have uses in
your future professional and personal endeavors.
Also, you should note that most time-value-of-money problems, including compound-interest
problems, can be solved by spreadsheet formulas, such as those included in Microsoft Excel.
Because computers are not allowed in the proctored final examinations, however, the spreadsheet
method of solution is not emphasized in this course.
Moving from the Future-Value to the Present-Value Concept
As stated earlier, in practice financial management generally has a greater use for present value
than future value, and typically we discount all future cash flows back to the present for proper
comparative financial analysis and decision making. Determining the present value—that is, the
value in today’s dollars of a sum (or stream) of cash flows to be received in the future—is
nothing other than the inverse of compounding. The difference in these techniques comes about
merely from the investor’s perspective in time.
Mathematically, the present value (PV) formula can be derived by algebraically rearranging the
compounding formula developed above to solve for the PV:
FVn = PV(1 + i)n
Rearrange the future value formula to algebraically solve for PV, and you obtain:
PV = FVn/(1 + i)n
where again:
FVn = future value at the end of n periods
PV = present value, or original amount, at the beginning of period 1
n = number of periods of discounting
i = interest rate per period
Again, similar to the compound-value formula, PV financial tables can be constructed using this
formula. They can be constructed in two ways, either by using the present value (PV) formula or
by dividing the FVIF table values into 1, because, by definition, the PV is the reciprocal of the
future value (FV). Once these tables are constructed, they can be used to solve PV discounting
problems with the following formula:
PV = FVn (PVIF i,n)
where PVIFi,n represents the appropriate financial table discounting factor for interest rate i, and
periods n. These PV factors are shown in the present value of $1 table in your textbook.
Future-Value/Present-Value Relationship to Variables
It is important that you understand that compounding (future value) and discounting (present
value) are reciprocals of each other. If you know either factor, you can calculate the other by
taking the reciprocal. To illustrate the inverse relationship between compounding and
discounting, the following presentation will show the graphical effect of compounding and
discounting $100.00 for five years at interest rates of 0%, 5%, and 10%.
Future-Value/Present-Value Relationship to Variables
The following presentation will show the graphical effects of first compounding and then
discounting $100.00 over a five-year period at interest rates of 0 percent, 5 percent, and 10
percent.
You should now set up and solve several simple financial problems for both present value and
future value to understand clearly what happens to each of these values as the interest rate (i) and
number of periods (n) change. One way to do so is to use the above graphical problem and solve
two consecutive years (3, 4) for all three rates (0%, 5%, and 10%). Be sure to change only one
variable at a time. Make a table of the results, and you should see clearly the inverse relationship
of present value to future value, as shown in the graphical presentation above.
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Annuities (Future Value and Present Value)
With the present/future value concepts understood, we can now discuss another common
financial application that is used in bonds, interest payments, pensions, and so forth—the
annuity. An annuity is the special case cash flow where a series of equal dollar payments is made
for a specified number of periods. Typically, financial management is interested in determining
either the future value or present value of an annuity.
The Future Value of an Annuity
It is important to remember that the period payment amount in an annuity must be a constant for
all periods. The development of the general annuity formula for the future-value case (a
compound annuity) is based on the constant-payment amount (PMT) and the previously
developed formula for calculating future value (1 + i)t. This is illustrated below for the future
value of a three-year annuity of $500 for three years at 6%:
FV3 = (PMT)(1 + i)3 + (PMT)(1 + i)2 + (PMT)(1 + i)1 + (PMT)
Obviously, this formula can be reduced to a general formula by factoring out the period payment,
PMT, and summing the discounted year payments from t = 1 to n – 1 periods, as shown below:
The future value formula for an annuity.
where:
FVn = future value of the annuity
(PMT) = constant payment deposited or received each period
i = interest rate per period
n = number of periods
The future value of an annuity can also be expressed in the alternative financial table format:
FVn = PMT (FVIFAi, n)
where:
The Future value of an Annuity Factor
The Present Value of an Annuity
The development of a general formula for the present value of an annuity is the reciprocal of the
future value of an annuity and follows the same logical progression to arrive at:
where:
PV = present value of the future annuity
(PMT) = constant payment deposited or received each period
i = interest rate per period
n = number of periods
Or expressed in financial table format:
PV = PMT (FVIFA i, n) The present value of an annuity factor.
Present Value of an Uneven or Complex Cash Flow
In the real world, the majority of cash flows that must be financially analyzed are typically not
single cash flows or equal-payment annuities, but rather cash streams with varying amounts per
period. This type of cash flow is called complex cash flow and requires a special approach to
determine its present value. The present value of a complex cash flow stream can always be
found by discounting the cash flows for each individual year by multiplying the present value
interest factor for that year (PVIFi, n) times the cash flow amount. The advantages of this
approach are that it is simple, accurate, always works, and does not require memorization of any
complex formulas.
For example, let’s compute the PV of the following complex cash stream, assuming a discount
rate of 6%.
Year $ Amount Factor (6%)* Discounted Amount
0.00 1.000 0.00
1 500.00 0.943 471.70
2 200.00 0.890 178.00
3 (400.00) 0.840 (335.84)
4 500.00 0.792 396.04
5 300.00 0.747 224.17
Total 1,100.00
Net present value $993.60
*From financial tables
Note that this answer developed using financial table values differs slightly from the
mathematical formula approach:
Manual method (above) ———- $933.50
Financial calculator ————— $934.07
This is not an unusual case, and slight differences between methods occur frequently because of
the number of significant digits used in the various methods of calculation. Both answers are
acceptable in this course.
Although this is a laborious method if calculated by use of either the financial tables or a regular
calculator, it becomes a relatively simple and quick method if one uses the cash-flow feature of
the financial calculator. We recommend taking the time to learn this method on your financial
calculator because you will encounter complex cash flows several times in this course.
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Bond Valuation
The Basics of Interest Rates
Additional Detail on Interest Rates
Key Characteristics of Bonds
Understanding Bonds
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Advantages and Disadvantages of Bonds
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Bond Valuation
(continued)
Types of Bonds
Bond Markets
Valuing Bonds
Bond Risk
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Understanding the Cost of Money
Interest Rate Levels
Drivers of Market Interest Rates
The Term Structure
The Basics of Interest Rates
Bond Valuation > The Basics of Interest Rates
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The concept of the cost of money has its basis, as does the subject of finance in general, in the time value of money.
The time value of money refers to the fact that a dollar in hand today is worth more than a dollar promised at some future time.
The trade-off between money now (holding money) and money later (investing) depends on, among other things, the rate of interest you can earn by investing. Therefore, interest is the cost of money.
Understanding the Cost of Money
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Cost Of Money
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Bond Valuation > The Basics of Interest Rates
In the U.S., the Federal Reserve (often referred to as ‘The Fed’) implements monetary policies largely by targeting the federal funds rate.
Expansionary monetary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding.
Contractionary monetary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values.
Crowding out is a phenomenon occurring when expansionary fiscal policy causes interest rates to rise, thereby reducing investment spending.
Interest Rate Levels
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Federal fund rates
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Bond Valuation > The Basics of Interest Rates
A market interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender in the market.
Economists generally agree that the interest rates yielded by any investment take into account: the risk-free cost of capital, inflationary expectations, the level of risk in the investment, and the costs of the transaction.
A basic interest rate pricing model for an asset is presented by the following formula: in = ir + pe + rp + lp.
Drivers of Market Interest Rates
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Worldwide Inflation Rates 2009
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Bond Valuation > The Basics of Interest Rates
Term structure of interest rates is often referred to as the yield curve.
The expectation hypothesis of the term structure of interest rates is the proposition that the long-term rate is determined by the market’s expectation for the short-term rate plus a constant risk premium.
The liquidity premium theory asserts that long-term interest rates not only reflect investors’ assumptions about future interest rates but also include a premium for holding long-term bonds.
In the segmented market hypothesis, financial instruments of different terms are not substitutable; therefore, supply and demand in the markets for short-term and long-term instruments is determined largely independently.
The Term Structure
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Yield curve for USD
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Bond Valuation > The Basics of Interest Rates
The Yield Curve
Using the Yield Curve to Estimate Interest Rates in the Future
Macroeconomic Factors Influencing the Interest Rate
Additional Detail on Interest Rates
Bond Valuation > Additional Detail on Interest Rates
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In finance the yield curve is a curve showing several yields or interest rates across different contract lengths for a similar debt contract.
Based on the shape of the yield curve, we have normal yield curves, steep yield curves, flat or humped yield curves, and inverted yield curves.
There are three main economic theories that attempt to explain different term structures of interest rates, namely the expectation hypothesis, the liquidity premium theory, and the segmented market hypothesis.
The Yield Curve
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Israel Shekel yield curve
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Bond Valuation > Additional Detail on Interest Rates
A normal yield curve tells us that investors believe the Federal Reserve is going to raise interest rates in the future.
A flat yield tells us that investors believe the Federal Reserve is going to be cutting interest rates.
An inverted yield curve tells us that investors believe the Federal Reserve is going to dramatically cut interest rates.
A flat curve expects unchanged interest rates in the future, sending signals of uncertainty in the economy.
An inverted yield curve occurs when long-term yields fall below short-term yields, indicating a fall in interest rates in the future.
Using the Yield Curve to Estimate Interest Rates in the Future
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Normal Yield Curve
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Bond Valuation > Additional Detail on Interest Rates
In economics, the Taylor rule is a monetary-policy rule that stipulates how much the Central Bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions.
If the inflationary expectation goes up, then so does the market interest rate and vice versa.
If output gap is positive, it is called an “inflationary gap,” possibly creating inflation, signaling a increase in interest rates made by the Central Bank; if output gap is negative, it is called a “recessionary gap,” possibly signifying deflation and a reduction in interest rates.
Macroeconomic Factors Influencing the Interest Rate
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Interest Rates in Turkey
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Bond Valuation > Additional Detail on Interest Rates
Par Value
Coupon Interest Rate
Maturity Date
Call Provisions
Sinking Funds
Other Features
Key Characteristics of Bonds
Bond Valuation > Key Characteristics of Bonds
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When a bond trades at a price above the face value, it is said to be selling at a premium. When a bond sells below face value, it is said to be selling at a discount.
A bond’s price fluctuates throughout its life in response to a number of variables, including interest rates and time to maturity.
Pull to par is the effect in which the price of a bond converges to par value as time passes. At maturity, the price of a debt instrument in good standing should equal its par (or face value).
Par Value
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Temporary bonds for the state of Kansas issued in 1922
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Bond Valuation > Key Characteristics of Bonds
Coupon interest rate is usually fixed throughout the life of the bond. It can also vary with a money market index.
Not all bonds have coupons. Zero-coupon bonds are those that pay no coupons and thus have a coupon rate of 0%.
Based on different coupon rates, there are fixed rate bonds, floating rate bonds, and inflation linked bonds.
Coupon Interest Rate
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Mecca Temple 1922 Bond Coupons
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Bond Valuation > Key Characteristics of Bonds
As long as all due payments have been made, the issuer has no further obligations to the bond holders after the maturity date.
The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond.
In the market for United States Treasury securities, there are three categories of bond maturities: short term, medium term, and long term.
Maturity Date
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Austrian war bond
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Bond Valuation > Key Characteristics of Bonds
A callable bond is a type of bond that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity.
If interest rates in the market have gone down by the time of the call date, the issuer will be able to refinance its debt at a cheaper level and so will be incentivized to call the bonds it originally issued.
Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, known as the call premium.
Price of callable bond = Price of straight bond – Price of call option. Price of a callable bond is always lower than the price of a straight bond because the call option adds value to an issuer.
Call Provisions
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Redeemed Bonds
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Bond Valuation > Key Characteristics of Bonds
Sinking fund provision of the corporate bond indenture requires a certain portion of the issue to be retired periodically.
A sinking fund reduces credit risk but presents reinvestment risk to bondholders.
For the creditors, the fund reduces the risk the organization will default when the principal is due: it reduces credit risk. However, if the bonds are callable, this comes at a cost to creditors, because the organization has an option on the bonds.
Sinking Funds
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Farm bond
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Bond Valuation > Key Characteristics of Bonds
The yield is the rate of return received from investing in the bond. It usually refers either to the current yield, or to the yield to maturity or redemption yield.
The market price of a tradeable bond will be influenced by the amounts, currency and timing of the interest payments and capital repayment due, the quality of the bond, and the available redemption yield of other comparable bonds which can be traded in the markets.
Some bonds give the holder the right to force the issuer to repay the bond before the maturity date on the put dates. These are referred to as retractable or putable bonds.
Other Features
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San Francisco Pacific Railroad Bond
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Bond Valuation > Key Characteristics of Bonds
The Nature of Bonds
Duration
Indenture
Ratings
Understanding Bonds
Bond Valuation > Understanding Bonds
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A bond is an instrument of indebtedness of the bond issuer to the holders. The issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity.
Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure.
Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders have an equity stake in the company (i.e. they are owners), whereas bondholders have a creditor stake in the company (i.e. they are lenders).
The Nature of Bonds
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A bond from the Dutch East India Company
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Bond Valuation > Understanding Bonds
A good approximation for bond price changes due to yield is the duration, a measure for interest rate risk.
The Macaulay duration is the name given to the weighted average time until cash flows are received and is measured in years. It really makes sense only for an instrument with fixed cash flows.
The modified duration is the name given to the price sensitivity and is the percentage change in price for a unit change in yield. It really makes sense only for an instrument with fixed cash flows.
The modified duration is a derivative (rate of change) or price sensitivity and measures the percentage rate of change of price with respect to yield. The concept of modified duration can be applied to interest-rate sensitive instruments with non-fixed cash flows.
Duration
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Macaulay duration
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Bond Valuation > Understanding Bonds
Terms of indentures include the interest rate, maturity date, repayment dates, convertibility, pledge, promises, representations, covenants, and other terms of the bond offering.
A bond indenture is held by a trustee. If the company fails to live up to the terms of the bond indenture, the trustee may bring legal action against the company on behalf of the bondholders.
The offering memorandum, also known as a prospectus, is a document that describes a financial security for potential buyers.
Indenture
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Indenture
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Bond Valuation > Understanding Bonds
Ratings play a critical role in determining how much companies and other entities that issue debt, including sovereign governments, have to pay to access credit markets; for example, the amount of interest they pay on their issued debt.
The ratings are assigned by credit rating agencies such as Moody’s, Standard & Poor’s, and Fitch. Ratings to have letter designations (such as AAA, B, CC), which represent the quality of a bond.
A bond is considered investment-grade (IG) if its credit rating is BBB- or higher by Standard & Poor’s, or Baa3 or higher by Moody’s, or BBB(low) or higher by DBRS. Bond ratings below BBB/Baa are not considered to be investment grade; such bonds are called junk bonds.
Ratings
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Credit Rating Equivalents
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Bond Valuation > Understanding Bonds
Advantages of Bonds
Disadvantages of Bonds
Advantages and Disadvantages of Bonds
Bond Valuation > Advantages and Disadvantages of Bonds
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Bonds are a debt security under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and or repay the principal at a later date, which is termed the maturity.
The volatility of bonds (especially short and medium dated bonds) is lower than that of equities (stocks). Thus bonds are generally viewed as safer investments than stocks.
Bonds are often liquid – it is often fairly easy for an institution to sell a large quantity of bonds without affecting the price much.
Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes bankrupt, its bondholders will often receive some money back (the recovery amount).
There are also a variety of bonds to fit different needs of investors.
Advantages of Bonds
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San Francisco Pacific Railroad Bond
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Bond Valuation > Advantages and Disadvantages of Bonds
A bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest and possibly repay the principal at a later date, which is termed the maturity.
Fixed rate bonds are subject to interest rate risk, meaning that their market prices will decrease in value when the generally prevailing interest rates rise.
Bonds are also subject to various other risks such as call and prepayment risk, credit risk, reinvestment risk, liquidity risk, event risk, exchange rate risk, volatility risk, inflation risk, sovereign risk, and yield curve risk.
A company’s bondholders may lose much or all their money if the company goes bankrupt. There is no guarantee of how much money will remain to repay bondholders.
Some bonds are callable. This creates reinvestment risk, meaning the investor is forced to find a new place for his money. As a consequence, the investor might not be able to find as good a deal, especially because this usually happens when interest rates are falling.
Disadvantages of Bonds
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Bond
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Bond Valuation > Advantages and Disadvantages of Bonds
Government Bonds
Zero-Coupon Bonds
Floating-Rate Bonds
Other Types of Bonds
Types of Bonds
Bond Valuation > Types of Bonds
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A government bond is a bond issued by a national government, generally promising to pay a certain amount (the face value) on a certain date, as well as periodic interest payments. Such bonds are often denominated in the country’s domestic currency.
In the primary market, Government Bonds are often issued via auctions at Stock Exchanges. In the secondary market, government bonds are traded at Stock Exchanges.
Although, government bonds are usually referred to as risk-free, there are currency, inflation, and default risks for government bondholders.
Government Bonds
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Government Bond
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Bond Valuation > Types of Bonds
Zero-coupon bonds may be created from fixed rate bonds by a financial institution separating (“stripping off”) the coupons from the principal. In other words, the separated coupons and the final principal payment of the bond may be traded separately.
Zero coupon bonds have a duration equal to the bond’s time to maturity, which makes them sensitive to any changes in the interest rates.
Pension funds and insurance companies like to own long maturity zero-coupon bonds since these bonds’ prices are particularly sensitive to changes in the interest rate and, therefore, offset or immunize the interest rate risk of these firms’ long-term liabilities.
Zero-Coupon Bonds
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SMAC bond
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Bond Valuation > Types of Bonds
FRBs are typically quoted as a spread over the reference rate. At the beginning of each coupon period, the coupon is calculated by taking the fixing of the reference rate for that day and adding the spread. A typical coupon would look like three months USD LIBOR +0.20%.
FRBs carry little interest rate risk. A FRB has a duration close to zero, and its price shows very low sensitivity to changes in market rates. As FRBs are almost immune to interest rate risk. The risk that remains is a credit risk.
Securities dealers make markets in FRBs. They are traded over the counter, instead of on a stock exchange. In Europe, most FRBs are liquid, as the biggest investors are banks. In the United States, FRBs are mostly held to maturity, so the markets aren’t as liquid.
Floating-Rate Bonds
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Municipal bond
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Bond Valuation > Types of Bonds
Bonds directly linked to interest rates include fixed rate bonds, floating rate bonds, and zero coupon bonds.
Convertible bonds are bonds that let a bondholder exchange a bond to a number of shares of the issuer’s common stock. Exchangeable bonds allows for exchange to shares of a corporation other than the issuer.
Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets.
Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of liquidation.
Foreign currency bonds are issued by companies, banks, governments, and other sovereign entities in foreign currencies, as it may appear to be more stable and predictable than their domestic currency.
Other Types of Bonds
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Government Bond
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Bond Valuation > Types of Bonds
Purchase Process
Price Transparency
Bond Markets
Bond Valuation > Bond Markets
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Buying a bond involves setting up an account with a broker and requesting that the broker buy bonds on the buyer’s behalf.
An individual can also purchase bonds by investing in bond funds, which hold baskets of bonds rather than competing for individual bond sales.
Most bond funds pay out dividends more frequently than individual bonds.
Purchase Process
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Bond Brokers
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Bond Valuation > Bond Markets
A market is transparent if much is known–by many–about what products, services, or capital assets are available at what price and where.
In most developed bond markets, such as the United States, Japan, and western Europe, bonds trade in decentralized, dealer-based, over-the-counter markets.
Poor transparency contributes to investor differences in bond valuations, as well as other inefficiencies that may lead to economic losses for market participants and, ultimately, inhibit business development.
Price Transparency
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New York Stock Exchange
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Bond Valuation > Bond Markets
Present Value of Payments
Par Value at Maturity
Yield to Maturity
Inflation Premium
Differences Between Real and Nominal Rates
Time to Maturity
Calculating Yield to Maturity Using the Bond Price
Impact of Payment Frequency on Bond Prices
Deciding to Refund Bonds
Valuing Bonds
Bond Valuation > Valuing Bonds
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The bond price can be summarized as the sum of the present value of the par value repaid at maturity and the present value of coupon payments.
The present value of coupon payments is the present value of an annuity of coupon payments.
The present value of an annuity is the value of a stream of payments, discounted by the interest rate to account for the payments being made at various moments in the future.
Present Value of Payments
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Bond Price
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Bond Valuation > Valuing Bonds
A bond selling at par has a coupon rate such that the bond is worth an amount equivalent to its original issue value or its value upon redemption at maturity.
A typical bond makes coupon payments at fixed intervals during the life of it and a final repayment of par value at maturity. Together with coupon payments, the par value at maturity is discounted back to the time of purchase to calculate the bond price.
Par value of a bond usually does not change, except for inflation-linked bonds whose par value is adjusted by inflation rates every predetermined period of time.
Par Value at Maturity
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Bond Price Formula
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Bond Valuation > Valuing Bonds
The Yield to maturity is the internal rate of return earned by an investor who bought the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments will be made on schedule.
Yield to maturity(YTM) = [(Face value/Present value)1/Time period]-1.
If the YTM is less than the bond’s coupon rate, then the market value of the bond is greater than par value (premium bond). If a bond’s coupon rate is less than its YTM, then the bond is selling at a discount. If a bond’s coupon rate is equal to its YTM, then the bond is selling at par.
There are some variants of YTM: yield to call, yield to put, yield to worst…
Yield to Maturity
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Yield to Maturity
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Bond Valuation > Valuing Bonds
Investors seek this premium to compensate for the erosion in the value of their capital due to inflation.
Actual interest rates (without factoring in inflation) are viewed by economists and investors as being the nominal (stated) interest rate minus the inflation premium.
Letting r denote the real interest rate, i denote the nominal interest rate, and let π denote the inflation rate, the Fisher equation is: i = r + π. In the Fisher equation, π is the inflation premium.
Inflation Premium
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Inflation rate graph
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Bond Valuation > Valuing Bonds
Nominal rate refers to the rate before adjustment for inflation; the real rate is the nominal rate minus inflation.
Fisher equation states that the real interest rate is approximately the nominal interest rate minus the inflation rate: 1 + i = (1+r) (1+E(r)).
Simple equation between nominal rates and real rates: i = R – r.
Differences Between Real and Nominal Rates
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Real and nominal
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Bond Valuation > Valuing Bonds
The maturity can be any length of time, but debt securities with a term of less than one year are generally not designated as bonds. Instead, they are considered money market instruments.
In the market for United States Treasury securities, there are three categories of bond maturities: short-term, medium-term and long-term bonds.
A bond that takes longer to mature necessarily has a greater duration. The bond price in this type of a situation, therefore, is more sensitive to changes in interest rates.
Time to Maturity
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Money market interest rates
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Bond Valuation > Valuing Bonds
To achieve a return equal to YTM (i.e., where it is the required return on the bond), the bond owner must buy the bond at price P0, hold the bond until maturity, and redeem the bond at par.
If a bond’s coupon rate is less than its YTM, then the bond is selling at a discount. If a bond’s coupon rate is more than its YTM, then the bond is selling at a premium. If a bond’s coupon rate is equal to its YTM, then the bond is selling at par.
Formula for yield to maturity: Yield to maturity(YTM) = [(Face value/Bond price)1/Time period]-1.
Calculating Yield to Maturity Using the Bond Price
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USD Yield Curve
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Bond Valuation > Valuing Bonds
Payment frequency can be annual, semi annual, quarterly, monthly, weekly, daily, or continuous.
Bond price is the sum of the present value of face value paid back at maturity and the present value of an annuity of coupon payments. The present value of face value received at maturity is the same. However, the present values of annuities of coupon payments vary among payment frequencies.
The more frequent a bond makes coupon payments, the higher the bond price, given equal coupon, par, and face.
Impact of Payment Frequency on Bond Prices
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Bond price formula
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Bond Valuation > Valuing Bonds
The issue of new, lower-interest debt allows the company to prematurely refund the older, higher-interest debt.
Bond refunding occurs when a) interest rates in the market are sufficiently less than the coupon rate on the old bond, b) the price of the old bond is less than par. and c) the sinking fund has accumulated enough money to retire the bond issue.
The decision of whether to refund a particular debt issue is usually based on a capital budgeting (present value) analysis.
Deciding to Refund Bonds
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French Bond
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Bond Valuation > Valuing Bonds
Price Risk
Reinvestment Risk
Comparing Price Risk and Reinvestment Risk
Default Risk
Bond Rating System
Bankruptcy and Bond Value
Bond Risk
Bond Valuation > Bond Risk
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The market price of bonds will decrease in value when the generally prevailing interest rates rise and vice versa.
Unless you plan to buy or sell them in the open market, changing interest rates do not affect the interest payments to the bondholder.
Price changes in a bond will immediately affect mutual funds that hold these bonds. If the value of the bonds in their trading portfolio falls, the value of the portfolio also falls.
Price Risk
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Bond price and yield
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Bond Valuation > Bond Risk
Reinvestment risk is more likely when interest rates are declining.
Reinvestment risk affects the yield-to-maturity of a bond, which is calculated on the premise that all future coupon payments will be reinvested at the interest rate in effect when the bond was first purchased.
Two factors that have a bearing on the degree of reinvestment risk are maturity of the bond and the coupon interest rate.
Reinvestment Risk
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Interest rates
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Bond Valuation > Bond Risk
Price risk and reinvestment risk are both the uncertainty associated with the effects of changes in market interest rates.
Price risk and changes in interest rates are positively correlated.
Reinvestment risk and changes in interest rates are inversely correlated.
Comparing Price Risk and Reinvestment Risk
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Pacific Railroad Bond
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Bond Valuation > Bond Risk
With default risk, the risk is primarily that of the bondholder and includes lost principal and interest, disruption to cash flows, and increased collection costs.
To reduce the bondholders’ credit risk, the lender may perform a credit check on the prospective borrower and may require the issuer to take out appropriate insurance.
A company’s bondholders may lose much or all their money if the company goes bankrupt. There is no guarantee of how much money will remain to repay bondholders.
Default Risk
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Prices of sovereign credit default swaps
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Bond Valuation > Bond Risk
In investment, the bond credit rating assesses the credit worthiness of a corporation’s or government debt issues.
The credit rating is a financial indicator to potential investors of debt securities, such as bonds. These are assigned by credit rating agencies such as Moody’s, Standard & Poor’s, and Fitch Ratings to have letter designations (such as AAA, B, CC) which represent the quality of a bond.
Bond ratings below BBB-/Baa are considered not to be investment grade and are colloquially called junk bonds.
Bond Rating System
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Bond rating
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Bond Valuation > Bond Risk
When a business is unable to service its debt or pay its creditors, it or its creditors can file with a federal bankruptcy court for protection under either Chapter 7 or Chapter 11 of the Bankruptcy code.
If a company goes bankrupt, its bondholders will often receive some money back (the recovery amount).
In a bankruptcy involving reorganization or recapitalization, as opposed to liquidation, bondholders may end up having the value of their bonds reduced, often through an exchange for a smaller number of newly-issued bonds.
Bankruptcy and Bond Value
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Bankruptcy Courthouse
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Bond Valuation > Bond Risk
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Appendix
Key terms
abscond To flee; to withdraw from.
annuity A specified income payable at stated intervals for a fixed or a contingent period, often for the recipient’s life, in consideration of a stipulated premium paid either in prior installment payments or in a single payment. For example, a retirement annuity paid to a public officer following his or her retirement.
asset-backed securities An asset-backed security is a security that has value and income payments derived from and collateralized (or “backed”) by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually.
bond funds A bond fund or debt fund is a fund that invests in bonds or other debt securities. Bond funds can be contrasted with stock funds and money funds.
call premium the additional cost paid by the issuer for the right to buy back the bond at a predtermined price at a certain time in the future
call provision the right for the issuer to buy back the bond at a predetermined price at a certain time in future
callable A callable bond (also called “redeemable bond”) is a type of bond (debt security) that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity.
clean price the price of a bond excluding any interest that has accrued since issue or the most recent coupon payment.
convertibility Quality of a bond that allows the holder to convert into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price.
Convertible bonds A convertible bond is a type of bond that the holder can convert into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price.
Convexity As interest rates change, the price does not change linearly, but rather is a convex function of interest rates. Convexity is a measure of the curvature of how the price of a bond changes as the interest rate changes. Specifically, duration can be formulated as the first derivative of the price function of the bond with respect to the interest rate in question, and the convexity as the second derivative.
corporate bonds A corporate bond is a bond issue by a corporation. It is a bond that a corporation issues to raise money effectively in order to expand its business.
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Bond Valuation
credit rating agencies A credit rating agency (CRA) is a company that assigns credit ratings to issuers of certain types of debt obligations, as well as to the debt instruments themselves.
debentures A debenture is a document that either creates a debt or acknowledges it, and it is a debt without collateral.
discount rate The interest rate used to discount future cash flows of a financial instrument; the annual interest rate used to decrease the amounts of future cash flow to yield their present value.
discount rate The interest rate used to discount future cash flows of a financial instrument; the annual interest rate used to decrease the amounts of future cash flow to yield their present value.
duration A measure of the sensitivity of the price of a financial asset to changes in interest rates, computed for a simple bond as a weighted average of the maturities of the interest and principal payments associated with it
duration A measure of the sensitivity of the price of a financial asset to changes in interest rates, computed for a simple bond as a weighted average of the maturities of the interest and principal payments associated with it
duration A measure of the sensitivity of the price of a financial asset to changes in interest rates, computed for a simple bond as a weighted average of the maturities of the interest and principal payments associated with it
Exchange rate risk The exchange rate risk is a financial risk posed by an exposure to unanticipated changes in the exchange rate between two currencies.
floating-rate bond a debt instruments with a variable coupon
gross domestic product A measure of the economic production of a particular territory in financial capital terms over a specific time period.
hedge funds An investment fund that can undertake a wider range of investment and trading activities than other funds, but which is generally only open to certain types of investors specified by regulators.
immunize In finance, interest rate immunization is a strategy that ensures that a change in interest rates will not affect the value of a portfolio. Similarly, immunization can be used to ensure that the value of a pension fund’s or a firm’s assets will increase or decrease in exactly the opposite amount of their liabilities, thus leaving the value of the pension fund’s surplus or firm’s equity unchanged, regardless of changes in the interest rate.
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indenture a document, written as duplicates separated by indentations, specifying such a contract
inflation An increase in the general level of prices or in the cost of living.
inflation-linked bonds Inflation-indexed bonds (also known as inflation-linked bonds or colloquially as linkers) are bonds where the principal is indexed to inflation. They are thus designed to cut out the inflation risk of an investment.
inflation-linked bonds Inflation-indexed bonds (also known as inflation-linked bonds or colloquially as linkers) are bonds where the principal is indexed to inflation. They are thus designed to cut out the inflation risk of an investment.
inflationary gap An inflationary gap, in economics, is the amount by which the real gross domestic product, or real GDP, exceeds potential GDP.
insolvent Unable to pay one’s bills as they fall due.
interest rate The percentage of an amount of money charged for its use per some period of time. It can also be thought of as the cost of not having money for one period, or the amount paid on an investment per year.
interest rate risk the potential for loss that arises for bond owners from fluctuating interest rates
internal rate of return IRR. The rate of return on an investment which causes the net present value of all future cash flows to be zero.
LIBOR The London Interbank Offered Rate is the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks.
LIBOR The London Interbank Offered Rate is the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks.
liquidated In law, liquidation is the process by which a company (or part of a company) is brought to an end and the assets and property of the company redistributed.
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liquidation The selling of the assets of a business as part of the process of dissolving the business.
liquidity Availability of cash over short term: ability to service short-term debt.
Liquidity premium Liquidity premium is a term used to explain a difference between two types of financial securities (e.g. stocks), that have all the same qualities except liquidity.
market liquidity In business, economics or investment, market liquidity is an asset’s ability to be sold without causing a significant movement in the price and with minimum loss of value.
monetary policy The process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.
money market A market for trading short-term debt instruments, such as treasury bills, commercial paper, bankers’ acceptances, and certificates of deposit
municipal bonds A municipal bond is a bond issued by an American city or other local government, or their agencies.
mutual funds A type of professionally-managed collective investment vehicle that pools money from many investors to purchase securities. While there is no legal definition, the term is most commonly applied only to those collective investment vehicles that are regulated, available to the general public and open-ended in nature.
Opportunity cost The cost of an opportunity forgone (and the loss of the benefits that could be received from that opportunity); the most valuable forgone alternative.
par Equal value; equality of nominal and actual value; the value expressed on the face or in the words of a certificate of value, as a bond or other commercial paper.
par value the stated value or amount of a bill or a note
Pension funds A pension fund is any plan, fund, or scheme which provides retirement income.
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Pension funds Any plan, fund, or scheme which provides retirement income.
Preferred Stock Stock with a dividend, usually fixed, that is paid out of profits before any dividend can be paid on common stock. It also has priority to common stock in liquidation.
premium the price above par value at which a security is sold
premium bond a debt instrument bought at a price above par value
public debt offerings A public debt offering is the offering of debt securities of a government, a company or a similar corporation to the public.
purchasing power Purchasing power (sometimes retroactively called adjusted for inflation) is the amount of goods or services that can be purchased with a unit of currency.
purchasing power Purchasing power (sometimes retroactively called adjusted for inflation) is the amount of goods or services that can be purchased with a unit of currency.
purchasing power parity a theory of long-term equilibrium exchange rates based on relative price levels of two countries
puttable Puttable bond (put bond, putable, or retractable bond) is a bond with an embedded put option. The holder of the puttable bond has the right, but not the obligation, to demand early repayment of the principal.
quote To name the current price, notably of a financial security.
Real interest rate The “real interest rate” is the rate of interest an investor expects to receive after allowing for inflation. It can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate.
recapitalization A restructuring of a company’s mixture of equity and debt.
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Recessionary gap An inflationary gap, in economics, is the amount by which the real Gross domestic product, or real GDP, is less than the potential GDP.
Reinvestment risk The reinvestment risk is the possibility that the investor might be forced to find a new place for his money. As a consequence, the investor might not be able to find as good a deal, especially because this usually happens when interest rates are falling.
resale market The resale market, also called “secondary market” or “aftermarket,” is the financial market in which previously issued financial instruments, such as stock, bonds, options, and futures, are bought and sold.
risk premium A risk premium is the minimum amount of money by which the expected return on a risky asset must exceed the known return on a risk-free asset, or the expected return on a less risky asset, in order to induce an individual to hold the risky asset rather than the risk-free asset.
sinking fund A sinking fund is a fund established by a government agency or business for the purpose of reducing debt by repaying or purchasing outstanding loans and securities held against the entity. It helps keep the borrower liquid so it can repay the bondholder.
straight bond A straight bond is a bond with no embedded options (call or put options).
systematic risks In finance and economics, systematic risk (sometimes called aggregate risk, market risk, or undiversifiable risk) is vulnerability to events which affect aggregate outcomes such as broad market returns, total economy-wide resource holdings, or aggregate income.
term structure of interest rates the relationship between the interest on a debt contract and the maturity of the contract
time value of money The value of money, figuring in a given amount of interest, earned over a given amount of time.
tranches One of a number of related securities offered as part of the same transaction.
transparency (figuratively) openness, degree of accessibility to view
treasury bill Treasury bills (or T-Bills) mature in one year or less. They do not pay interest prior to maturity; instead they are sold at a discount of the par value to create a positive yield to maturity.
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Bond Valuation
treasury bill A United States Treasury security is a government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States federal government. They are often referred to simply as treasuries. There are four types of marketable treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS), in which Treasury bills have the shortest maturity of one year or less.
Treasury bond Treasury bonds (T-Bonds, or the long bond) have the longest maturity of government securities, from 20 to 30 years. They have a coupon payment every six months, and are commonly issued with maturity of 30 years
Treasury bond A United States Treasury security is a government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States federal government, and they are often referred to simply as Treasuries. There are four types of marketable treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS), in which Treasury bonds have the longest maturity, from 20 years to 30 years.
Treasury bonds A United States Treasury bond is a government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt, with a maturity of 20 years to 30 years.
yield curve the graph of the relationship between the interest on a debt contract and the maturity of the contract
Yield to maturity The yield to maturity (YTM) of a bond or other fixed-interest security, such as gilts, is the internal rate of return (IRR, overall interest rate) earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity and that all coupon and principal payments will be made on schedule.
Yield to maturity The internal rate of return on a bond held to maturity, assuming scheduled payment of principal and interest.
Yield to maturity The Yield to maturity (YTM) or redemption yield of a bond or other fixed-interest security, such as gilts, is the internal rate of return (IRR, overall interest rate) earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments will be made on schedule.
Zero coupon bonds A zero-coupon bond (also called a discount bond or deep discount bond) is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity.
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Bond Valuation
Eurozone Government Bonds Yield
Development of yield to maturity of bonds of 2019 maturity of a number of Eurozone governments.
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Bond Valuation
Normal Yield Curve
A normal yield curve tells us that investors believe the Federal Reserve is going to raise interest rates in the future.
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Informed Trades. “Bonds – Yield: Curves and Spreads – InformedTrades.”
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Bond Valuation
Bond price formula
Bond price is the present value of all coupon payments and the face value paid at maturity.
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A bond from the Dutch East India Company
A bond is a financial security that represents a promise by a company or government to repay a certain amount, with interest, to the bondholder.
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Bond Valuation
Municipal bond
Municipal bond issued in 1929 by city of Kraków (Poland).
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Worldwide Inflation Rates 2009
World map showing inflation rate by country.
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Bond Valuation
Farm bond
One purpose of a sinking fund is to repurchase outstanding bonds.
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Bankruptcy Courthouse
Old U.S. Post Office and Court House, now used by the U.S. Bankruptcy Court for the Northern District of Florida.
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Bond Valuation
Bond Price
Bond price is the present value of coupon payments and face value paid at maturity.
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Prices of sovereign credit default swaps
Credit default swaps are an instrument to protect against default risk. This image shows the monthly prices of sovereign credit default swaps from January 2010 till September 2011 of Greece, Portugal, Ireland, Hungary, Italy, Spain, Belgium, France, Germany, and the UK (Greece is illustrated by blue line). Higher credit default swap prices mean that investors perceive a higher risk of default.
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Bond Valuation
Austrian war bond
The first Austrian bonds had 5% rates of return and a five-year maturity.
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Europeana. “Austrian War Bond, item 1.”
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Bond Valuation
Yield to Maturity
Development of yield to maturity of bonds of 2019 maturity of a number of Eurozone governments.
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Bond Valuation
Inverted Yield Curve
An inverted yield curve tells us that investors believe the Federal Reserve is going to dramatically cut interest rates.
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Informed Trades. “Bonds – Yield: Curves and Spreads – InformedTrades.”
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Bond Valuation
Mecca Temple 1922 Bond Coupons
A coupon payment on a bond is a periodic interest payment that the bond holder receives during the time between when the bond is issued and when it matures.
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USD Yield Curve
2005 USD yield curve
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Money market interest rates
Interest rates of one-month maturity of German banks from 1967 to 2003
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Bond Valuation
Indenture
Bond indenture (also trust indenture or deed of trust) is a legal contract issued to lenders.
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Yield curve for USD
The US dollar yield curve as of February 9, 2005. The curve has a typical upward sloping shape.
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Bond Valuation
Redeemed Bonds
This Bond is one of the 400 issued to the Central Pacific Rail Road Company of California and 200 to the Western Pacific Rail Road Company in 1865 under the Act of the California Legislature passed on April 22, 1863. Coupon #1 was redeemed and cancelled on November 2, 1865, and coupon #35 on November 2, 1882, at which time the principal of $1,000.00 in gold coin was also paid from the Treasury of the City and County of San Francisco and the Bond was cancelled.
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Bond Valuation
Bond Price Formula
Bond price is the present value of coupon payments and the par value at maturity.
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Modified duration
The modified duration is the name given to the price sensitivity and is the percentage change in price for a unit change in yield.
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Bond Valuation
French Bond
French Bond for the Akhtala mines issued in 1887.
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Bond Valuation
San Francisco Pacific Railroad Bond
$1,000 (30 year, 7%) “Pacific Railroad Bond” (#93 of 200) issued by the City and County of San Francisco under “An Act to Authorize the Board of Supervisors of the City and County of San Francisco to take and subscribe One Million Dollars to the Capital Stock of the Western Pacific Rail Road Company and the Central Pacific Rail Road Company of California and to provide for the payment of the same and other matters relating thereto” approved on April 22, 1863, as amended by section Five of the “Compromise Act” approved on April 4, 1864, to fund the construction of the Western Pacific Railroad between San Francisco Bay (at Alameda) and the CPRR of Cal. at Sacramento, dated May 1, 1865.
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Bond Valuation
Bond Brokers
Bonds can be purchased through brokerages, such Fidelity Investments.
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Bond Valuation
Israel Shekel yield curve
This graph is an example of a yield curve on Israeli Non-Linked Fixed Rate government bonds.
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Flat Yield Curve
A flat yield tells us that investors believe the Federal Reserve is going to cut interest rates.
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Informed Trades. “Bonds – Yield: Curves and Spreads – InformedTrades.”
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Bond Valuation
Pacific Railroad Bond
$1,000 (30 year, 7%) “Pacific Railroad Bond” (#93 of 200) issued by the City and County of San Francisco.
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Bond Valuation
Real and nominal
The relationship between real and nominal interest rates is captured by the formula.
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Interest Rates in Turkey
Overnight rates in Turkey are estimated to fall in 2013, indicating a loosened monetary policy.
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Bond Valuation
Macaulay duration
The Macaulay duration is the name given to the weighted average time until cash flows are received and is measured in years.
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Annuity formula
The formula to calculate PV of annuities.
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Government Bond
The short-term bond of Kolchak government in 1919 with a face value of 500 rubles.
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Bond Valuation
San Francisco Pacific Railroad Bond
A bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon). In addition, the issuer might have to repay the principal at a later date, which is termed the maturity.
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Wikipedia. “South Carolina consolidation bond.”
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Bond Valuation
Bond
A bond is a debt owned by the enterprise to the bondholder.
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Bond Valuation
Cost Of Money
The cost of money is the opportunity cost of holding money in hands instead of investing it.
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Flickr. “All sizes | Interest rate vs money balance | Flickr – Photo Sharing!.”
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Bond Valuation
Temporary bonds for the state of Kansas issued in 1922
Par values of these bonds were $50, $100, $10000, and $3000.
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Bond Valuation
SMAC bond
Bond on VMOK with the signature on Boris Saraf.
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Bond Valuation
New York Stock Exchange
Most bonds are not sold in centralized marketplaces, such as the New York Stock Exchange, leading to a lack of price transparency.
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Bond Valuation
Bond rating
Bond ratings below BBB-/Baa are considered to be not investment grade and are colloquially called “junk bonds. ”
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Federal fund rates
The effective federal funds rate in the U.S. charted over more than half a century.
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Wikipedia. “Interest rate.”
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Bond Valuation
Interest rates
Reinvestment risk is more likely when interest rates are declining.
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Wikimedia. “Long term interest rates.”
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Bond Valuation
Government Bond
Bond of National Loan issued by Polish National Government in 1863.
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Wikimedia. “Bond of National Loan issued by Polish National Government 1863.”
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Bond Valuation
Inflation rate graph
Inflation rate in the Confederacy during the American Civil War.
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Wikimedia. “Confederate inflation.”
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Bond Valuation
Bond price and yield
Several curves depicting the inverse relationship between bond price and yield (interest rates).
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Bond Valuation
Credit Rating Equivalents
Credit ratings are used to report on the credit worthiness of a bond issuing company or government
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Wikipedia. “Bond rating.”
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Bond Valuation
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Bond Valuation
The cost of money is related to the concept of ___.
A) the time value of money.
B) time preference.
C) opportunity cost.
D) All of these answers.
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Bond Valuation
The cost of money is related to the concept of ___.
A) the time value of money.
B) time preference.
C) opportunity cost.
D) All of these answers.
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Bond Valuation
When crowding out occurs, investment spending decreases. What causes this phenomenon?
A) The total money supply is increased, increasing interest rates.
B) The total money supply is increased, decreasing interest rates.
C) The total money supply is decreased, increasing interest rates.
D) The total money supply is decreased, decreasing interest rates.
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Bond Valuation
When crowding out occurs, investment spending decreases. What causes this phenomenon?
A) The total money supply is increased, increasing interest rates.
B) The total money supply is increased, decreasing interest rates.
C) The total money supply is decreased, increasing interest rates.
D) The total money supply is decreased, decreasing interest rates.
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Bond Valuation
An investment has a risk premium of 5% and a liquidity premium of 4%. The nominal interest rate on the instrument is 8%. Expected inflation is 3%. What is the nominal interest rate of the bond?
A) 20%
B) 16%
C) 17%
D) 15%
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Bond Valuation
An investment has a risk premium of 5% and a liquidity premium of 4%. The nominal interest rate on the instrument is 8%. Expected inflation is 3%. What is the nominal interest rate of the bond?
A) 20%
B) 16%
C) 17%
D) 15%
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Bond Valuation
Which yield curve theory is based on the premises that financial instruments of different terms are not substitutable and therefore the supply and demand in the markets for short-term and long-term instruments is determined largely independently?
A) The expectation hypothesis.
B) The liquidity premium theory.
C) All of these answers.
D) The segmented market hypothesis.
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Bond Valuation
Which yield curve theory is based on the premises that financial instruments of different terms are not substitutable and therefore the supply and demand in the markets for short-term and long-term instruments is determined largely independently?
A) The expectation hypothesis.
B) The liquidity premium theory.
C) All of these answers.
D) The segmented market hypothesis.
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Bond Valuation
Which of the following is a correct description of a type of yield curve?
A) All of these answers.
B) When all maturities have similar yields, the resulting curve is flat.
C) When long-term yields fall below short-term yields, the curve is inverted.
D) When long-term yields are higher than short-term yields, the curve is normal.
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Bond Valuation
Which of the following is a correct description of a type of yield curve?
A) All of these answers.
B) When all maturities have similar yields, the resulting curve is flat.
C) When long-term yields fall below short-term yields, the curve is inverted.
D) When long-term yields are higher than short-term yields, the curve is normal.
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Bond Valuation
Which of the following predictions based on a description of the yield curve is correct?
A) A normal yield curve suggests that interest rates will be raised in the future.
B) A flat yield curve suggest that interest rates will be cut.
C) An inverted yield curve suggests that interest rates will be dramatically cut.
D) All of these answers.
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Bond Valuation
Which of the following predictions based on a description of the yield curve is correct?
A) A normal yield curve suggests that interest rates will be raised in the future.
B) A flat yield curve suggest that interest rates will be cut.
C) An inverted yield curve suggests that interest rates will be dramatically cut.
D) All of these answers.
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Bond Valuation
Which of the following statements regarding the relationship between economic factors and the nominal inflation rate is true?
A) If the inflationary expectation goes up, the market interest rate decreases.
B) If there is an inflationary gap, there will be a corresponding reduction in interest rates.
C) All of these answers.
D) For every 1% increase in inflation, the nominal interest rate should be raised by more than 1%.
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Bond Valuation
Which of the following statements regarding the relationship between economic factors and the nominal inflation rate is true?
A) If the inflationary expectation goes up, the market interest rate decreases.
B) If there is an inflationary gap, there will be a corresponding reduction in interest rates.
C) All of these answers.
D) For every 1% increase in inflation, the nominal interest rate should be raised by more than 1%.
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Bond Valuation
When does a bond usually sell at its par value?
A) When the bond matures.
B) When the bond is first issued.
C) When the bond’s coupon rate is the same as the bond’s yield to maturity.
D) All of these answers.
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Bond Valuation
When does a bond usually sell at its par value?
A) When the bond matures.
B) When the bond is first issued.
C) When the bond’s coupon rate is the same as the bond’s yield to maturity.
D) All of these answers.
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Bond Valuation
A bond makes only one payment – the payment of the face value on the maturity date. The bond is sold at a discount. What type of bond is this?
A) Zero-coupon bond
B) Inflation linked bond.
C) Floating rate note.
D) Stepped-coupon bond.
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Bond Valuation
A bond makes only one payment – the payment of the face value on the maturity date. The bond is sold at a discount. What type of bond is this?
A) Zero-coupon bond
B) Inflation linked bond.
C) Floating rate note.
D) Stepped-coupon bond.
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Bond Valuation
A bond pays a coupon rate equal to the LIBOR rate plus 0.30%. The coupon rate is recalculated every three months. What type of bond is this?
A) An inflation linked bond.
B) A floating rate note.
C) A stepped-coupon bond.
D) A zero-coupon bond.
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Bond Valuation
A bond pays a coupon rate equal to the LIBOR rate plus 0.30%. The coupon rate is recalculated every three months. What type of bond is this?
A) An inflation linked bond.
B) A floating rate note.
C) A stepped-coupon bond.
D) A zero-coupon bond.
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Bond Valuation
A US Treasury security matures in 7 years. What type of security is it?
A) A bill.
B) A note.
C) A money market instrument.
D) A bond.
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Bond Valuation
A US Treasury security matures in 7 years. What type of security is it?
A) A bill.
B) A note.
C) A money market instrument.
D) A bond.
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Bond Valuation
A US Treasury security matures in 4 years. What type of treasury is it?
A) A bill.
B) A money market instrument.
C) A note.
D) A bond.
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Bond Valuation
A US Treasury security matures in 4 years. What type of treasury is it?
A) A bill.
B) A money market instrument.
C) A note.
D) A bond.
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Bond Valuation
The terms of a bond allows its issuer to redeem the security at anytime. This type of bond is _____.
A) a Bermudan callable.
B) a European callable.
C) an Asian callable.
D) an American callable.
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Bond Valuation
The terms of a bond allows its issuer to redeem the security at anytime. This type of bond is _____.
A) a Bermudan callable.
B) a European callable.
C) an Asian callable.
D) an American callable.
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Bond Valuation
The terms of a bond allow its issuer to redeem the bond on December 31st, four years after the bond was issued. The issuer can only redeem the bond on that date. This type of bond is ____ .
A) an American callable.
B) a Bermudan callable.
C) an Asian callable.
D) a European callable.
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Bond Valuation
The terms of a bond allow its issuer to redeem the bond on December 31st, four years after the bond was issued. The issuer can only redeem the bond on that date. This type of bond is ____ .
A) an American callable.
B) a Bermudan callable.
C) an Asian callable.
D) a European callable.
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Bond Valuation
A sinking fund is used by firms to retire some of its outstanding debt every year. Which of the following is a way that a sinking fund may operate?
A) All of these answers
B) The firm may repurchase the bonds in the open market.
C) The firm may buy the bonds at a special call price stipulated in the bond’s sinking fund provision.
D) The firm may repurchase the bonds at the current market price or the call price, whichever is lower.
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Bond Valuation
A sinking fund is used by firms to retire some of its outstanding debt every year. Which of the following is a way that a sinking fund may operate?
A) All of these answers
B) The firm may repurchase the bonds in the open market.
C) The firm may buy the bonds at a special call price stipulated in the bond’s sinking fund provision.
D) The firm may repurchase the bonds at the current market price or the call price, whichever is lower.
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Bond Valuation
A company issues a bond with a coupon rate of 5%. Since the bond was issued, market interest rates have decreased. What effect will this decrease have on the bond’s market price and its current yield?
A) The bond will trade above par and its current yield will increase.
B) The bond will trade above par and its current yield will decrease.
C) The bond will trade below par and its current yield will decrease.
D) The bond will trade below par and its current yield will increase.
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Bond Valuation
A company issues a bond with a coupon rate of 5%. Since the bond was issued, market interest rates have decreased. What effect will this decrease have on the bond’s market price and its current yield?
A) The bond will trade above par and its current yield will increase.
B) The bond will trade above par and its current yield will decrease.
C) The bond will trade below par and its current yield will decrease.
D) The bond will trade below par and its current yield will increase.
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Bond Valuation
Which of the following is NOT a type of bond?
A) Certificate of deposits (CDs)
B) Treasuries
C) Corporate Bonds
D) Municipal Bonds
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Bond Valuation
Which of the following is NOT a type of bond?
A) Certificate of deposits (CDs)
B) Treasuries
C) Corporate Bonds
D) Municipal Bonds
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Bond Valuation
Which of the following describes a difference between stocks and bonds?
A) Bonds always have a defined term while stocks may be outstanding indefinitely.
B) Stocks can be resold on a secondary market, while bonds cannot.
C) Stockholders generally have an equity stake in the business while bondholders have a creditor stake.
D) All of these answers.
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Bond Valuation
Which of the following describes a difference between stocks and bonds?
A) Bonds always have a defined term while stocks may be outstanding indefinitely.
B) Stocks can be resold on a secondary market, while bonds cannot.
C) Stockholders generally have an equity stake in the business while bondholders have a creditor stake.
D) All of these answers.
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Bond Valuation
Which of the following are debt instruments that companies use as investments? Choose one answer.
A) Stocks
B) Bank Loans
C) Unpaid Accounts
D) Bonds
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Bond Valuation
Which of the following are debt instruments that companies use as investments? Choose one answer.
A) Stocks
B) Bank Loans
C) Unpaid Accounts
D) Bonds
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Bond Valuation
Which of the following is the definition of the Macaulay duration?
A) The percentage change in price for a unit change in yield.
B) The price sensitivity of a bond.
C) All of these answers.
D) The weighted average time, measured in years, until cash flows are received.
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Bond Valuation
Which of the following is the definition of the Macaulay duration?
A) The percentage change in price for a unit change in yield.
B) The price sensitivity of a bond.
C) All of these answers.
D) The weighted average time, measured in years, until cash flows are received.
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Bond Valuation
Which of the following specifications regarding a bond is contained in the bond’s indenture?
A) All of these answers.
B) The maturity date.
C) The interest rate.
D) The bond’s pledge.
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Bond Valuation
Which of the following specifications regarding a bond is contained in the bond’s indenture?
A) All of these answers.
B) The maturity date.
C) The interest rate.
D) The bond’s pledge.
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Bond Valuation
Which of the following entities “holds” the indenture and is responsible for enforcing the contract?
A) The bondholders.
B) The shareholders.
C) All of these answers.
D) A trustee.
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Bond Valuation
Which of the following entities “holds” the indenture and is responsible for enforcing the contract?
A) The bondholders.
B) The shareholders.
C) All of these answers.
D) A trustee.
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Bond Valuation
Which of the following ratings would indicate a “junk bond?”
A) A Baa3 rating by Moody’s.
B) A Ba rating by Moody’s.
C) A BBB- rating from Standard & Poors.
D) BBB(low) by DBRS.
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Bond Valuation
Which of the following ratings would indicate a “junk bond?”
A) A Baa3 rating by Moody’s.
B) A Ba rating by Moody’s.
C) A BBB- rating from Standard & Poors.
D) BBB(low) by DBRS.
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Bond Valuation
Which of the following statements regarding the advantages of bonds as an investment, are true?
A) The market price of bonds are less volatile than stocks.
B) Bonds are more liquid than stock.
C) If a company goes bankrupt, its bondholders will recover the entirety of the bond’s principal.
D) All of these answers.
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Bond Valuation
Which of the following statements regarding the advantages of bonds as an investment, are true?
A) The market price of bonds are less volatile than stocks.
B) Bonds are more liquid than stock.
C) If a company goes bankrupt, its bondholders will recover the entirety of the bond’s principal.
D) All of these answers.
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Bond Valuation
Which of the following statements about the disadvantages of bonds as investments is correct?
A) Bonds are subject to prepayment risk, credit risk, reinvestment risk, and yield curve risk.
B) When a bond issuer is able to pay off a bond early, the bond is subject to event risk.
C) Interest rate risk is only a problem if the bondholder decides to hold the bond until it matures.
D) All of these answers.
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Bond Valuation
Which of the following statements about the disadvantages of bonds as investments is correct?
A) Bonds are subject to prepayment risk, credit risk, reinvestment risk, and yield curve risk.
B) When a bond issuer is able to pay off a bond early, the bond is subject to event risk.
C) Interest rate risk is only a problem if the bondholder decides to hold the bond until it matures.
D) All of these answers.
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Which of the following statements about government bonds is NOT true?
A) Government bonds are referred to as “risk-free” because they are generally free of credit risk.
B) Government bonds are “risk-free” because they are free of currency risk.
C) Government bonds are often issued via auctions at stock exchanges.
D) To minimize inflation risk, many countries issue inflation-indexed bonds.
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Bond Valuation
Which of the following statements about government bonds is NOT true?
A) Government bonds are referred to as “risk-free” because they are generally free of credit risk.
B) Government bonds are “risk-free” because they are free of currency risk.
C) Government bonds are often issued via auctions at stock exchanges.
D) To minimize inflation risk, many countries issue inflation-indexed bonds.
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Which of the following statements about zero coupon bonds is NOT true?
A) U.S. Treasury bills and saving bonds are example of zero coupon bonds.
B) The impact of interest rate fluctuations on zero coupon bonds is higher than for coupon bonds.
C) Zero coupon bonds are particularly popular with pension and insurance companies.
D) When a bond is “stripped,” it is split into two parts; the principal and the coupons, or “residue.”
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Bond Valuation
Which of the following statements about zero coupon bonds is NOT true?
A) U.S. Treasury bills and saving bonds are example of zero coupon bonds.
B) The impact of interest rate fluctuations on zero coupon bonds is higher than for coupon bonds.
C) Zero coupon bonds are particularly popular with pension and insurance companies.
D) When a bond is “stripped,” it is split into two parts; the principal and the coupons, or “residue.”
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Which of the following statements about floating rate bonds (FRBs) is NOT true?
A) In Europe, FRBs are generally issued by banks.
B) An FRB with a maximum coupon is called a “capped FRB.”
C) FRBs carry significant interest rate risk; its price declines as market rates rise.
D) An FRBs spread is a rate that remains constant.
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Bond Valuation
Which of the following statements about floating rate bonds (FRBs) is NOT true?
A) In Europe, FRBs are generally issued by banks.
B) An FRB with a maximum coupon is called a “capped FRB.”
C) FRBs carry significant interest rate risk; its price declines as market rates rise.
D) An FRBs spread is a rate that remains constant.
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You purchase a bond from a corporation that allows you to exchange the bond for some of the company’s stock. You just purchased ________.
A) an asset-based security.
B) a convertible bond.
C) a registered bond.
D) a serial bond.
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Bond Valuation
You purchase a bond from a corporation that allows you to exchange the bond for some of the company’s stock. You just purchased ________.
A) an asset-based security.
B) a convertible bond.
C) a registered bond.
D) a serial bond.
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Which of the following statements regarding the bond purchasing process is correct?
A) Some insurance companies are legally required to own bonds to match their liabilities.
B) Individual investors can purchase bonds through a broker or a bond fund.
C) Bond funds generally pay higher interest than certificates of deposits and money market accounts.
D) All of these answers.
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Bond Valuation
Which of the following statements regarding the bond purchasing process is correct?
A) Some insurance companies are legally required to own bonds to match their liabilities.
B) Individual investors can purchase bonds through a broker or a bond fund.
C) Bond funds generally pay higher interest than certificates of deposits and money market accounts.
D) All of these answers.
Free to share, print, make copies and changes. Get yours at www.boundless.comBond Valuation
Which of the following is a reason bond markets may lack price transparency.
A) There are a large number of debt issues outstanding.
B) Bond markets sometimes lack a centralized exchange or trading system.
C) All of these answers.
D) In the US, Europe and Japan, bonds are traded in dealer-based over-the-counter markets.
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Bond Valuation
Which of the following is a reason bond markets may lack price transparency.
A) There are a large number of debt issues outstanding.
B) Bond markets sometimes lack a centralized exchange or trading system.
C) All of these answers.
D) In the US, Europe and Japan, bonds are traded in dealer-based over-the-counter markets.
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An annuity has an interest rate of 7% and makes a quarterly payment of $2000. The annuity is to last for 5 years. What is the present value of the annuity.
A) $8,200.40
B) $32,801.58
C) $21,188.03
D) $2,118.80
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Bond Valuation
An annuity has an interest rate of 7% and makes a quarterly payment of $2000. The annuity is to last for 5 years. What is the present value of the annuity.
A) $8,200.40
B) $32,801.58
C) $21,188.03
D) $2,118.80
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Which of the following statements regarding bonds and par values is true?
A) The par value of a bond never changes.
B) Corporate bonds usually have par values equal to $10,000.
C) All of these answers.
D) A bond selling at par has a coupon rate so the bond is worth its redemption value at maturity.
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Bond Valuation
Which of the following statements regarding bonds and par values is true?
A) The par value of a bond never changes.
B) Corporate bonds usually have par values equal to $10,000.
C) All of these answers.
D) A bond selling at par has a coupon rate so the bond is worth its redemption value at maturity.
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A bond has a coupon rate of 7% and a yield to maturity rate of 8%. The bond is ____.
A) selling at a discount.
B) selling at par.
C) selling at a premium.
D) selling at yield
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Bond Valuation
A bond has a coupon rate of 7% and a yield to maturity rate of 8%. The bond is ____.
A) selling at a discount.
B) selling at par.
C) selling at a premium.
D) selling at yield
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A bond grants its holder the option to sell the bond back to the issuer at a fixed price at a fixed date prior to the bond’s maturity. When evaluating the bond’s value, the company should calculate the bond’s _____.
A) yield to call.
B) yield to worst.
C) yield to put.
D) yield to discount.
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Bond Valuation
A bond grants its holder the option to sell the bond back to the issuer at a fixed price at a fixed date prior to the bond’s maturity. When evaluating the bond’s value, the company should calculate the bond’s _____.
A) yield to call.
B) yield to worst.
C) yield to put.
D) yield to discount.
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Which of the following statements regarding the calculation and use of inflation premiums is true?
A) Actual interest rates are viewed as being the nominal interest rate minus the inflation premium.
B) An inflation premium is caused by lender compensating for expected inflation.
C) The inflation premium varies based on each analyst’s expectations regarding future inflation.
D) All of these answers.
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Bond Valuation
Which of the following statements regarding the calculation and use of inflation premiums is true?
A) Actual interest rates are viewed as being the nominal interest rate minus the inflation premium.
B) An inflation premium is caused by lender compensating for expected inflation.
C) The inflation premium varies based on each analyst’s expectations regarding future inflation.
D) All of these answers.
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Given an inflation rate of 4% and a real rate of 5%, what is the corresponding nominal rate?
A) 9%
B) 9.2%
C) 4%
D) 109.2%
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Bond Valuation
Given an inflation rate of 4% and a real rate of 5%, what is the corresponding nominal rate?
A) 9%
B) 9.2%
C) 4%
D) 109.2%
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Which of the following statements regarding a bond’s time to maturity is true?
A) United States Treasury Bonds have maturities between six to twelve years.
B) A bond with a shorter maturity generally has a higher price than one with a longer maturity.
C) The fair price of a “straight bond” is the sum of its discounted expected cash flows.
D) All of these answers.
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Bond Valuation
Which of the following statements regarding a bond’s time to maturity is true?
A) United States Treasury Bonds have maturities between six to twelve years.
B) A bond with a shorter maturity generally has a higher price than one with a longer maturity.
C) The fair price of a “straight bond” is the sum of its discounted expected cash flows.
D) All of these answers.
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A zero-coupon bond has a face value of $1000 and a market value of $800. The bond will mature in 5 years. What is its yield to maturity?
A) 104.56%
B) -4.37%
C) 205.17%
D) 4.56%
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Bond Valuation
A zero-coupon bond has a face value of $1000 and a market value of $800. The bond will mature in 5 years. What is its yield to maturity?
A) 104.56%
B) -4.37%
C) 205.17%
D) 4.56%
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A bond has a face value of $1000 and a contractual interest rate of 5%. The bond has quarterly interest payments. The market interest rate is 4%. The bond matures in 5 years and will pay $1000. What is the bond’s current market price?
A) $875.38
B) $679.52
C) $1044.52
D) $1135.90
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Bond Valuation
A bond has a face value of $1000 and a contractual interest rate of 5%. The bond has quarterly interest payments. The market interest rate is 4%. The bond matures in 5 years and will pay $1000. What is the bond’s current market price?
A) $875.38
B) $679.52
C) $1044.52
D) $1135.90
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Which of the following must be true before a company will refund one of its bond issues?
A) The price of the old bond is at par.
B) Interest rates in the market are at most equal to the coupon rate on the old bond.
C) The sinking fund has accumulated enough money to retire the bond issue.
D) All of these answers.
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Bond Valuation
Which of the following must be true before a company will refund one of its bond issues?
A) The price of the old bond is at par.
B) Interest rates in the market are at most equal to the coupon rate on the old bond.
C) The sinking fund has accumulated enough money to retire the bond issue.
D) All of these answers.
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Which of the following is the correct order of steps to take when making a decision to refund a bond issue?
A) Calculate the PV of interest savings, calculate the PV or refunding, calculate the net investment.
B) Calculate the net investment, calculate the PV or refunding, calculate the PV of interest savings,.
C) Calculate the PV of interest savings, calculate the net investment, calculate the PV or refunding.
D) Calculate the PV of interest savings, calculate the net investment, calculate the PV or refunding.
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Bond Valuation
Which of the following is the correct order of steps to take when making a decision to refund a bond issue?
A) Calculate the PV of interest savings, calculate the PV or refunding, calculate the net investment.
B) Calculate the net investment, calculate the PV or refunding, calculate the PV of interest savings,.
C) Calculate the PV of interest savings, calculate the net investment, calculate the PV or refunding.
D) Calculate the PV of interest savings, calculate the net investment, calculate the PV or refunding.
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Which of the following influences a bond’s price risk?
A) The possibility the issuing company’s credit rating will be decreased.
B) The possibility that market interest rates will increase.
C) Mutual funds, pension managers and banks divest themselves of the issuing company’s bonds.
D) All of these answers.
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Bond Valuation
Which of the following influences a bond’s price risk?
A) The possibility the issuing company’s credit rating will be decreased.
B) The possibility that market interest rates will increase.
C) Mutual funds, pension managers and banks divest themselves of the issuing company’s bonds.
D) All of these answers.
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Which of the following factors influence the reinvestment risk associated with a bond?
A) All of these answers.
B) The maturity of the bond.
C) The interest rate of the bond.
D) The market interest rate.
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Bond Valuation
Which of the following factors influence the reinvestment risk associated with a bond?
A) All of these answers.
B) The maturity of the bond.
C) The interest rate of the bond.
D) The market interest rate.
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Which of the following explains the difference between price risk and reinvestment risk?
A) Price risk is positively correlated to maturity, reinvestment risk is inversely correlated.
B) Price risk is positively correlated to interest rates, reinvestment risk is inversely correlated.
C) For corporate planning, a bond’s price risk is a bigger concern than its reinvestment risk.
D) All of these answers.
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Bond Valuation
Which of the following explains the difference between price risk and reinvestment risk?
A) Price risk is positively correlated to maturity, reinvestment risk is inversely correlated.
B) Price risk is positively correlated to interest rates, reinvestment risk is inversely correlated.
C) For corporate planning, a bond’s price risk is a bigger concern than its reinvestment risk.
D) All of these answers.
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Which of the following can occur to a bondholder if the issuing company defaults?
A) The bondholder will not be paid the bond’s principal and any outstanding interest payments.
B) All of these answers.
C) The bondholder’s cash flows may be disrupted.
D) The bondholder may have to pay collection costs.
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Bond Valuation
Which of the following can occur to a bondholder if the issuing company defaults?
A) The bondholder will not be paid the bond’s principal and any outstanding interest payments.
B) All of these answers.
C) The bondholder’s cash flows may be disrupted.
D) The bondholder may have to pay collection costs.
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Which of the following is NOT a class of credit ratings that a Nationally Recognized Statistical Rating Organization (NRSRO) can register to review?
A) Insurance companies.
B) Financial institutions, brokers, and dealers.
C) Individuals.
D) Issuers of government securities.
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Bond Valuation
Which of the following is NOT a class of credit ratings that a Nationally Recognized Statistical Rating Organization (NRSRO) can register to review?
A) Insurance companies.
B) Financial institutions, brokers, and dealers.
C) Individuals.
D) Issuers of government securities.
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When an issuing company goes bankrupt, the bondholders are always paid before which of the following the parties?
A) The bank lenders.
B) The company’s shareholders.
C) The company’s trade creditors.
D) All of these answers.
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Bond Valuation
When an issuing company goes bankrupt, the bondholders are always paid before which of the following the parties?
A) The bank lenders.
B) The company’s shareholders.
C) The company’s trade creditors.
D) All of these answers.
AttributionWikipedia. “Reinvestment risk.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Reinvestment_riskWikipedia. “Yield to maturity.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Yield%20to%20maturityWikipedia. “Maturity date.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Maturity_dateWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)#MaturityWikipedia. “puttable.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/puttableWiktionary. “callable.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/callableWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)#MaturityWikipedia. “Bond valuation.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_valuationWiktionary. “money market.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/money+marketWikipedia. “duration.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/durationWikipedia. “Transparency (market).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Transparency_(market)Wikipedia. “market liquidity.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/market%20liquidityWiktionary. “transparency.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/transparencyWikipedia. “Yield to maturity.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Yield_to_maturityWikipedia. “Bond pricing.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_pricingWiktionary. “discount rate.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/discount+rateWikipedia. “Bond rating.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_rating
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Wikipedia. “asset-backed securities.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/asset-backed%20securitiesWikipedia. “Yield to maturity.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Yield_to_maturityWikipedia. “internal rate of return.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/internal%20rate%20of%20returnWikipedia. “Bond option.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_optionWikipedia. “quote.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/quoteWikipedia. “Bond pricing.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_pricingWiktionary. “discount rate.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/discount+rateWikipedia. “Government bond.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Government_bondWiktionary. “purchasing power parity.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/purchasing+power+parityWiktionary. “purchasing power.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/purchasing+powerWikipedia. “Government debt.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Government_debt#Government_and_sovereign_bondsWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “Zero-coupon bond.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Zero-coupon_bondWikipedia. “immunize.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/immunizeWikipedia. “Pension funds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Pension%20fundsWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)#CouponWikipedia. “Coupon (bond).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Coupon_(bond)Wikipedia. “time value of money.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/time%20value%20of%20moneyWikipedia. “Interest rate risk.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Interest_rate_risk
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Wiktionary. “liquidity.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/liquidityWiktionary. “abscond.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/abscondWiktionary. “inflation.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/inflationWikipedia. “Interest.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/InterestWikipedia. “Duration (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Duration_(finance)Wikipedia. “Yield to maturity.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Yield%20to%20maturityWikipedia. “Convexity.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/ConvexityWikipedia. “Par value.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Par_valueWikipedia. “Bond pricing.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_pricingWikipedia. “inflation-linked bonds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/inflation-linked%20bondsWikipedia. “Bond refunding.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_refundingWikipedia. “sinking fund.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/sinking%20fundWikipedia. “Yield curve.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Yield_curveWikipedia. “Term structure of interest rates.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Term_structure_of_interest_ratesWikipedia. “treasury bill.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/treasury%20billWikipedia. “Treasury bond.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Treasury%20bondWikipedia. “Interest rate.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Interest_rateWikipedia. “Output gap.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Output_gapWikipedia. “Taylor rule.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Taylor_rule
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Wikipedia. “Recessionary gap.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Recessionary%20gapWikipedia. “inflationary gap.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/inflationary%20gapWikipedia. “Real interest rate.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Real%20interest%20rateInformed Trades. “Bonds – Yield: Curves and Spreads – InformedTrades.”
CC BYhttp://www.informedtrades.com/blogs/magic/1753-bonds-yield-curves-spreads.htmlWikipedia. “Yield curve.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Yield_curveWikipedia. “Treasury bond.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Treasury%20bondWikipedia. “treasury bill.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/treasury%20billWikipedia. “Term structure.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Term_structure#Types_of_yield_curveWikipedia. “risk premium.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/risk%20premiumWikipedia. “Term structure of interest rates.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Term_structure_of_interest_ratesWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)#Market_PriceWikipedia. “premium.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/premiumWiktionary. “Liquidity premium.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/Liquidity+premiumWikipedia. “Present value.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Present_valueWikibooks. “Principles of Finance/Section 1/Chapter 2/Time Value of Money/Opportunity Cost.”
CC BY-SA 3.0http://en.wikibooks.org/wiki/Principles_of_Finance/Section_1/Chapter_2/Time_Value_of_Money/Opportunity_CostWikipedia. “Interest.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/InterestWiktionary. “interest rate.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/interest+rateWiktionary. “Opportunity cost.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/Opportunity+costWikipedia. “Real versus nominal value (economics).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Real_versus_nominal_value_(economics)
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Wikipedia. “Interest rate.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Interest_rateWikibooks. “Principles of Finance/Section 1/Chapter/Financial Markets and Institutions/Interest.”
CC BY-SA 3.0http://en.wikibooks.org/wiki/Principles_of_Finance/Section_1/Chapter/Financial_Markets_and_Institutions/InterestWikipedia. “Crowding out (economics).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Crowding_out_(economics)Wiktionary. “monetary policy.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/monetary+policyWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “inflation-linked bonds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/inflation-linked%20bondsWikipedia. “Zero coupon bonds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Zero%20coupon%20bondsWikipedia. “Convertible bonds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Convertible%20bondsWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “Exchange rate risk.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Exchange%20rate%20riskWikipedia. “Reinvestment risk.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Reinvestment%20riskWikipedia. “Bond indenture.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_indentureWikipedia. “Prospectus (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Prospectus_(finance)Wiktionary. “indenture.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/indentureWikipedia. “convertibility.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/convertibilityWikipedia. “public debt offerings.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/public%20debt%20offeringsWikipedia. “Bond pricing.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_pricingWikipedia. “Annuity (finance theory).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Annuity_(finance_theory)Wikipedia. “Payment schedule.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Payment_schedule
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Wiktionary. “annuity.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/annuityWikipedia. “municipal bonds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/municipal%2520bondsWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “Treasury bonds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Treasury%2520bondsWikipedia. “corporate bonds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/corporate%2520bondsWikipedia. “Pull to par.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Pull_to_parWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)#PrincipalWikipedia. “Par value.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Par_valueWikipedia. “resale market.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/resale%20marketWiktionary. “par value.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/par+valueWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “Bond option.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_optionWikipedia. “debentures.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/debenturesWikipedia. “Preferred Stock.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Preferred%20StockWikipedia. “Sinking fund.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Sinking_fundWikipedia. “clean price.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/clean%20priceWikipedia. “Yield to maturity.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Yield%20to%20maturityWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)#OthersWikipedia. “Floating-rate bond.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Floating-rate_bond
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Wikipedia. “Floating rate note.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Floating_rate_noteWikipedia. “duration.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/durationWikipedia. “LIBOR.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/LIBORWikipedia. “Credit risk.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Credit_riskWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “liquidated.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/liquidatedWiktionary. “insolvent.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/insolventWikipedia. “Chapter 11, Title 11, United States Code.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Chapter_11,_Title_11,_United_States_CodeWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wiktionary. “liquidation.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/liquidationWiktionary. “recapitalization.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/recapitalizationWikipedia. “Interest rate.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Interest_rate#Real_vs_nominal_interest_ratesWikipedia. “Nominal interest rate.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Nominal_interest_rateWikipedia. “Real interest rate.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Real_interest_rateWiktionary. “purchasing power.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/purchasing+powerWikipedia. “Fisher equation.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Fisher_equationWikipedia. “Real interest rate.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Real_interest_rateWikipedia. “systematic risks.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/systematic%20risksWikipedia. “Real interest rate.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Real_interest_rate
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Wikipedia. “Reinvestment risk.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Reinvestment_riskWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “duration.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/durationWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “mutual funds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/mutual%20fundsWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “tranches.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/tranchesWiktionary. “gross domestic product.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/gross+domestic+productWikipedia. “LIBOR.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/LIBORWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “Broker.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/BrokerWikipedia. “Bond fund.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_fundWikipedia. “hedge funds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/hedge%20fundsWikipedia. “Pension funds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Pension%20fundsWikipedia. “bond funds.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/bond%20fundsWikipedia. “Bond rating.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_ratingWikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)Wikipedia. “credit rating agencies.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/credit%20rating%20agenciesWikipedia. “Callable bond.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Callable_bond
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Wikipedia. “Bond (finance).”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Bond_(finance)#MaturityWikipedia. “Call option.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/Call_optionWiktionary. “par.”
CC BY-SA 3.0http://en.wiktionary.org/wiki/parWikipedia. “straight bond.”
CC BY-SA 3.0http://en.wikipedia.org/wiki/straight%20bond
Free to share, print, make copies and changes. Get yours at www.boundless.comBond Valuation
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