FIN 3320 Exam 3 Review Questions
and Answers
bond sells at a discount - ANSWER-- market rate > coupon rate
- price < par
- high risk
- PV < FV
- current yield (CY) < yield to maturity (YTM)
as discount rate increases, PV ________ - ANSWER-decreases
as coupon rate increases, PV - ANSWER-increases
yield to maturity (YTM) - ANSWER-- discount rate that equates bond price to the
present value of all promised cash flows
- yield promised to an investor who holds the bond until maturity (under certain
assumptions)
premium bond price will _________ with time - ANSWER-decrease
discount bond price will ________ with time - ANSWER-increase
interest rate risk (price risk) - ANSWER-- risk associated with price fluctuations
caused by interest rate changes
- price moves indirectly with interest rates
longer term bonds will have a _______ interest rate risk - ANSWER-greater
lower coupon bonds will have a _______ interest rate risk - ANSWER-greater
if a bond is held to maturity, __________________ is irrelevant - ANSWER-interest
rate risk
reinvestment rate risk - ANSWER-- risk that coupon rate will fall, and future cash
flows will have to be reinvested at lower rates
- to earn the YTM, coupons must be reinvested at the same YTM. If this is not
achieved, final yield will be different
interest rate risk and reinvestment rate risk work in ______________ directions -
ANSWER-opposite
default risk - ANSWER-- risk issuer wont make payments as specified in the contract
- default = not paying full amount, not paying at the appropriate time
- bond rating agencies assess the default risk of borrowers
, default premium - ANSWER-higher interest rate to compensate the bondholder for
the risk of default
zero coupon bonds - ANSWER-- coupon rate of 0%
- par repayment is the only cash flow
- sell at discount
- all else equal, have a greater interest rate risk
floating rate bonds - ANSWER-- coupon payments change over the bonds life
- reduces interest rate risk
consol bonds - ANSWER-they pay interest forever and never mature -- they are
perpetuities
bonds with options - ANSWER-- option gives one party the ability to change the
terms of the contract
- option benefits the borrower -- higher interest rates (borrower pays the attached
option)
- option benefits the lender -- lower interest rates (lender pays the attached option)
convertible bond - ANSWER-- conversion option gives the bondholder the ability to
convert the bond into a specified number of shares of the issuer's stock
- often issued by young firms
- if stock price increases, bondholder converts -- if it doesn't increase, bondholder
does nothing
convertible bond will have a _____________ interest rate, all else equal (lender pays
the attached option) - ANSWER-lower
callable bond - ANSWER-- call option allows issuer to pay bond off early at a pre-
specified price and time (call it in)
- call price is typically greater than par
- if interest rates go down, issuer can call the bonds in and then reissue at a lower
rate
yield to call (YTC) - ANSWER-yield calculation that assumes bond will be called in
callable bonds will have a __________ interest rate, all else equal (borrower pays
the attached option) - ANSWER-higher
puttable bond - ANSWER-- put option allows bondholder to sell bond to issuer early
at a pre specified price and time
- put price is typically lower than par
- if interest rates go up, bondholder can sell the bonds to borrower and the re buy at
a higher rate
puttable bonds will have a __________ interest rate, all else equal (lender pays the
attached option) - ANSWER-lower
and Answers
bond sells at a discount - ANSWER-- market rate > coupon rate
- price < par
- high risk
- PV < FV
- current yield (CY) < yield to maturity (YTM)
as discount rate increases, PV ________ - ANSWER-decreases
as coupon rate increases, PV - ANSWER-increases
yield to maturity (YTM) - ANSWER-- discount rate that equates bond price to the
present value of all promised cash flows
- yield promised to an investor who holds the bond until maturity (under certain
assumptions)
premium bond price will _________ with time - ANSWER-decrease
discount bond price will ________ with time - ANSWER-increase
interest rate risk (price risk) - ANSWER-- risk associated with price fluctuations
caused by interest rate changes
- price moves indirectly with interest rates
longer term bonds will have a _______ interest rate risk - ANSWER-greater
lower coupon bonds will have a _______ interest rate risk - ANSWER-greater
if a bond is held to maturity, __________________ is irrelevant - ANSWER-interest
rate risk
reinvestment rate risk - ANSWER-- risk that coupon rate will fall, and future cash
flows will have to be reinvested at lower rates
- to earn the YTM, coupons must be reinvested at the same YTM. If this is not
achieved, final yield will be different
interest rate risk and reinvestment rate risk work in ______________ directions -
ANSWER-opposite
default risk - ANSWER-- risk issuer wont make payments as specified in the contract
- default = not paying full amount, not paying at the appropriate time
- bond rating agencies assess the default risk of borrowers
, default premium - ANSWER-higher interest rate to compensate the bondholder for
the risk of default
zero coupon bonds - ANSWER-- coupon rate of 0%
- par repayment is the only cash flow
- sell at discount
- all else equal, have a greater interest rate risk
floating rate bonds - ANSWER-- coupon payments change over the bonds life
- reduces interest rate risk
consol bonds - ANSWER-they pay interest forever and never mature -- they are
perpetuities
bonds with options - ANSWER-- option gives one party the ability to change the
terms of the contract
- option benefits the borrower -- higher interest rates (borrower pays the attached
option)
- option benefits the lender -- lower interest rates (lender pays the attached option)
convertible bond - ANSWER-- conversion option gives the bondholder the ability to
convert the bond into a specified number of shares of the issuer's stock
- often issued by young firms
- if stock price increases, bondholder converts -- if it doesn't increase, bondholder
does nothing
convertible bond will have a _____________ interest rate, all else equal (lender pays
the attached option) - ANSWER-lower
callable bond - ANSWER-- call option allows issuer to pay bond off early at a pre-
specified price and time (call it in)
- call price is typically greater than par
- if interest rates go down, issuer can call the bonds in and then reissue at a lower
rate
yield to call (YTC) - ANSWER-yield calculation that assumes bond will be called in
callable bonds will have a __________ interest rate, all else equal (borrower pays
the attached option) - ANSWER-higher
puttable bond - ANSWER-- put option allows bondholder to sell bond to issuer early
at a pre specified price and time
- put price is typically lower than par
- if interest rates go up, bondholder can sell the bonds to borrower and the re buy at
a higher rate
puttable bonds will have a __________ interest rate, all else equal (lender pays the
attached option) - ANSWER-lower
