FINA 469 Lecture Notes - Lecture 12: High-Yield Debt, Premium Bond, Zero-Coupon Bond

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ambermuskrat630

16 Apr 2017

School

USC, SC, Carolina, South Carolina

Department

Finance

Course

FINA 469

Professor

Gregory Putnam

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Document Summary

1000$ bond with 10$ coupon, 2 period bond. If interest rate declines to 8%, 100$ reinvest at 8% --> 108$ Ytm: average rate of return if investment held to maturity. Hpr: rate of return over investment period depends on market price at end of period. If interest rate decreases 2%, price goes up (premium bond) If interest rate increases 2%, prices goes down (discount bond) price premium discount. The further from maturity, the more impact of change in interest rate. Investment grade bond: bbb and above or baa and above. Speculative or junk bond: below bbb or below bab. Profitability rate of return on assets or equity. Bond indenture: defines contract between issuer and holder. Sinking fund: indenture calling for issuer to periodically repurchase outstanding bonds before maturity. Subordination clause: restrictions on additional borrowing stipulating senior bondholders paid first in case of bankruptcy. Reference bond for corporate bond trading: us treasury at similar maturity.

Related Questions

You want to make a 5-year investment on bonds, and if you buy bonds with longer period of maturity, they will be sold at the prevailing market price at the end of the fifth year. All coupons will be reinvested. You forecast that the rates are going to change after you purchase the bonds. Now you have three bonds with same initial YTM to consider: A. 5-year maturity, 6% coupon paid annually, YTM=9% B. 10-year maturity, 8% coupon paid annually, YTM=9% C. 15-year maturity, 4% coupon paid annually, YTM=9% To pick the best one, you want to calculate the following:

1) What are the current prices of three bonds based on the initial YTM given? [2 points]Current prices of all bonds are shown below Bond 1: n=5; PMT = 6; YTM = 9%; FV = 100; PV=calculate = 88.33 It can be calculated by putting the values in the financial calculator OR by using the PV formule in excel which is =PV(9%,5,6,100) Bond 2 n=10; PMT = 8; YTM = 9%; FV = 100; PV=calculate = 93.58 Bond 3 n=15; PMT = 4; YTM = 9%; FV = 100; PV=calculate = 59.7

2) If the coupon payments are reinvested at the prevailing market rate (7% for the coming 5 years), what are the future values (at the end of the fifth year) of all five coupon payments for three bonds respectively? [3 points]

3) What are the selling prices of three bonds at the end of the fifth year, given that the prevailing market rate is 8% at that time? (For bond A, use its par value as the final selling price, as it will mature in 5 years). [2 points]

4) What are the HPRs for the three bonds? [2 points] 5) Whatâs your recommendation? [1 point]

yellowcaribou187

Fill in the blank using a number of terms listed below (@1 point per question).

Beta coefficient, Bonds, CAPM, Cash flows, Change, CV, Convertible bonds, Correlation, Correlation coefficient, Debenture, Discount, Diversifiable risk, Expected return, Interest rate risk, Inverted, Junk Bonds, Market risk, More, Normal, Opposite, Probability distribution, Ratings, Reinvestment rate risk, Risk, Risk averse investor, Risk premium, Standard deviation

When interest rates move up or down, bond prices move in the _________________ direction.

_____________ are referred to as non-amortized debt, which means interest is paid regularly during the term, usually semiannually, whereas repayment of principal does not occur until the maturity date.

The longer a bond has to maturity, _______________ sensitive the bondâs price is to changes in market interest rates. This is called ________________________.

Bonds with short maturities expose investors to high ____________________, which is the risk that income from a bond portfolio will decline because cash flows received from bonds will be rolled over at lower interest rates.

A bond with an annual coupon payment of $100 originally sold at par for $1,000. Market interest rates are currently 12%. This bond would be selling at a _____________ in order to compensate the purchaser for the below market coupon rate.

Once a bond has been issued, if the holder of the bond retains it until maturity the market value of the bond may ________________, but the ________________ will not.

An unsecured bond is referred to as a(n) __________________.

____________________ can generally be issued at somewhat lower interest rates than regular bonds.

Double-B and lower bonds are speculative, to be called _______________.

Bonds are assigned _____________ that reflect the probability of their going into default. The higher it is, the lower its risk and therefore its interest rate.

When the yield curve slopes upward, it is said to be _______________, because it is like this most of the time. Conversely, a downward-slopping yield curve is termed ______________.

QUESTION 1 The largest investors in corporate bonds are life insurance companies and pension funds. True False 5 points QUESTION 2 Most secondary market transactions for corporate bonds take place through dealers in the over-the-counter (OTC) market. True False 5 points QUESTION 3 The value (or price) of a bond is the present value of its expected future cash flows. True False 5 points QUESTION 4 Bond prices decline when the interest rate decreases. True False 5 points QUESTION 5 The face or par value for bonds is the amount paid to bondholders at maturity and is usually equal to $1,000. True False 5 points QUESTION 6 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond. True False 5 points QUESTION 7 Zero coupon bonds have no coupon payments so they sell for more than their par value. True False 5 points QUESTION 8 Interest rate risk is the risk that bond prices will fluctuate when the interest rate changes. True False 5 points QUESTION 9 US Treasury securities are considered risky investments because the coupon payments are unpredictable. True False 5 points QUESTION 10 Bonds are very difficult to value because their future cash flows are very difficult to predict. True False 5 points QUESTION 11 If the bond's coupon rate is equal to the market rate then the bond will sell at a price equal to its face value greater than its face value less than its face value equal to its foreign currency value, e.g., its price in British pounds 5 points QUESTION 12 When calculating the price of a bond that pays a semiannual coupon one needs to use double the number of years until maturity for the number of payments use half the annual coupon payment use half the annual rate of return as the discount rate all of the above 5 points QUESTION 13 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments more than the price of the bond equal to zero equal to the price of the bond less than the price of the bond 5 points QUESTION 14 Which one of the following statements is true? All else equal long-term bonds have lower price volatility than short-term bonds. There is an inverse relation between bond prices and market interest rates. All else equal short-term bonds are more risky than long-term bonds. All else equal US government bonds are more risky than corporate bonds. 5 points QUESTION 15 An investor owns a 10-year US government bond with a 9 percent coupon rate. If the yield-to-maturity on the bond is 8 percent then this bond is selling for its par value. a discount. a premium. its face value. 5 points QUESTION 16 BA Corp is issuing a 10-year bond with a coupon rate of 8 percent and a par value of $1,000. The market interest rate on similar bonds is currently 6 percent. If the coupon payments are made annually, what is the value of this bond? 5 points QUESTION 17 Knight, Inc. has issued a 3-year bond with a $1,000 par value and an annual coupon rate of 6 percent. The current market rate of interest is 5 percent. What is the value of this bond if the coupon payments are made semiannually? 5 points QUESTION 18 Diane Carter is interested in buying a 5-year zero coupon bond with a face value of $5,000. If the market interest rate on these types of bonds is currently 9 percent, what is the current price of this bond? 5 points QUESTION 19 Rudy Sandberg wants to invest in 4-year bonds that are currently priced at $933.76. The bonds have a coupon rate of 6 percent and annual coupon payments. If the par value of the bonds is $1,000, what is the bond's yield-to-maturity? 5 points QUESTION 20 You own a 5-year bond with a face value of $1,000 and a coupon rate of 5 percent with annual payments. The bond is currently worth $810.46. If market interest rates remain unchanged, what will be the value of the bond next year when there are 4 years left until maturity?

FINA 469 Lecture Notes - Lecture 12: High-Yield Debt, Premium Bond, Zero-Coupon Bond

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