p.1
Bond Cash Payments and Structure
What are the cash payments from a bond until maturity?
Regular interest payments and the face value at maturity.
p.1
Bond Pricing and Interest Rate Relationship
How are bond prices typically expressed?
As a percentage of face value.
p.12
Types of Bonds: Government vs. Corporate
What are stripped bonds?
Bonds that make a single payment at a specific time.
p.7
Duration and Its Impact on Bond Prices
What does duration represent in bond valuation?
The weighted average of the times to each of the cash payments.
p.8
Duration and Its Impact on Bond Prices
What is modified duration?
Duration divided by one plus the yield to maturity.
p.8
Duration and Its Impact on Bond Prices
How does modified duration relate to bond price changes?
It measures the percentage change in bond price for a 1 percentage-point change in yield.
p.1
Bond Cash Payments and Structure
What is the total cash payment received at maturity for the OAT?
€106.00 (final interest payment plus principal).
p.2
Yield to Maturity and Its Calculation
What is the yield to maturity of a bond priced at 144.99% with a coupon payment of 6.00%?
The yield to maturity is 0.3%.
p.9
Bond Cash Payments and Structure
What should you enter for the frequency of coupon payments in the PRICE and YLD functions?
1 for annual payments or 2 for semiannual.
p.7
Duration and Its Impact on Bond Prices
What is the measure used to predict a bond's price exposure to interest rate fluctuations?
Duration or Macaulay duration.
p.6
Duration and Its Impact on Bond Prices
Which bond would benefit more from a fall in yields, the 3s or the 9s?
The 3s would benefit more due to their longer effective life.
p.5
Bond Pricing and Interest Rate Relationship
What occurs when the yield is higher than the bond's coupon rate?
The bond sells at a discount to face value.
p.6
Duration and Its Impact on Bond Prices
Which type of bond is more sensitive to interest rate fluctuations?
Long-term bonds are more sensitive to interest rate fluctuations than short-term bonds.
p.3
Bond Cash Payments and Structure
How are Treasury bonds, notes, and bills traded?
They are traded by a network of bond dealers, not on the stock exchange.
p.14
Expectations Theory of the Term Structure
What are three reasons an investor might hold one-year Treasuries despite low returns?
1. Expectation of higher future short-term rates. 2. Concern about long-term bond exposure to interest rate changes. 3. Risk of higher future inflation.
p.14
Expectations Theory of the Term Structure
What does the Expectations Theory of the Term Structure state?
Investment in a series of short-maturity bonds must offer the same expected return as a single long-maturity bond.
p.5
Bond Pricing and Interest Rate Relationship
What happens to bond prices when the yield to maturity is equal to the bond's coupon rate?
The bond sells for exactly its face value.
p.4
Yield to Maturity and Its Calculation
What significant change occurred in interest rates after 1979?
Interest rates climbed sharply due to Paul Volcker's tight money policy.
p.14
Expectations Theory of the Term Structure
What is the forward rate of interest?
The extra return for lending for one more year, which reflects future interest rate expectations.
p.1
Present Value Calculation for Bonds
What components make up the present value of a bond?
The present value of the annuity of coupon payments and the present value of the final payment of principal.
p.9
Duration and Its Impact on Bond Prices
Why is modified duration a good predictor of interest rate changes only for small moves?
Because the plot of price against yield is not a straight line.
p.13
Risk Factors in Long-term vs. Short-term Bonds
What is a potential cost that Ms. Kraft might incur when borrowing?
The bank would need to charge more than 7% on the loan to cover its costs.
p.15
Duration and Its Impact on Bond Prices
Why might long-duration bonds be more volatile than short-duration bonds?
A sharp increase in interest rates can significantly decrease the price of long-term bonds.
p.15
Risk Factors in Long-term vs. Short-term Bonds
What is a potential strategy for reducing exposure to inflation risk for long-term investors?
Investing in short-term securities and rolling over the investment.
p.5
Duration and Its Impact on Bond Prices
How sensitive are long-term bonds to changes in interest rates compared to short-term bonds?
The price of long-term bonds is more sensitive to changes in interest rates than that of short-term bonds.
p.9
Bond Pricing and Interest Rate Relationship
What does a 1% change in interest rates predict for bond price changes, according to the text?
A 5.47% change in bond price.
p.15
Risk Factors in Long-term vs. Short-term Bonds
What is the risk associated with investing in 20-year strips for retirement savings?
Uncertainty about future inflation and its impact on purchasing power.
p.4
Yield to Maturity and Its Calculation
How is the yield to maturity reported in terms of annual rate?
As R%, where R is the semiannual rate multiplied by 2.
p.11
Arbitrage and the Law of One Price
What does the law of one price state regarding cash payments?
The same commodity must sell at the same price in a well-functioning market.
p.12
Present Value Calculation for Bonds
Why does the discount factor decline as futurity increases?
The longer you have to wait for your money, the less its present value.
p.5
Bond Pricing and Interest Rate Relationship
How do bond prices react to changes in interest rates?
Bond prices move in opposite directions to interest rates; when interest rates rise, bond prices fall, and vice versa.
p.5
Yield to Maturity and Its Calculation
What is the yield to maturity?
The yield to maturity is the discount rate that explains the bond price.
p.2
Bond Cash Payments and Structure
How can a bond be valued?
As a package of an annuity (the coupon payments) and a single final payment (the repayment of principal).
p.14
Expectations Theory of the Term Structure
What happens if everyone expects future one-year rates to exceed 9%?
Investors would prefer to invest in one-year bonds and reinvest at the higher rate.
p.13
Arbitrage and the Law of One Price
What does the term 'arbitrage' refer to in financial markets?
The opportunity to make a risk-free profit by exploiting price differences.
p.2
Yield to Maturity and Its Calculation
What is the general procedure for calculating the yield to maturity?
Trial and error, or using a spreadsheet program or a specially programmed calculator.
p.3
Bond Cash Payments and Structure
What is the method for calculating accrued interest?
It varies from one type of bond to another.
p.11
Present Value Calculation for Bonds
How do you calculate the present value (PV) of cash flows using spot rates?
PV = 1 / (1 + r1) + 1 / (1 + r2)^2.
p.9
Duration and Its Impact on Bond Prices
What is the purpose of the MDURATION function in Excel?
To calculate the modified duration (or volatility) of a bond.
p.6
Duration and Its Impact on Bond Prices
What is the relationship between the timing of cash payments and bond price sensitivity?
Bonds with cash flows occurring later (at maturity) are more sensitive to interest rate changes.
p.8
Duration and Its Impact on Bond Prices
What is the relationship between coupon payments and duration calculations?
Duration calculations recognize that coupon payments are semiannual.
p.10
Term Structure of Interest Rates
What is the term structure of interest rates?
The relationship between short- and long-term interest rates.
p.10
Term Structure of Interest Rates
What happens to long-term interest rates in a downward-sloping term structure?
Long-term interest rates are lower than short-term rates.
p.13
Arbitrage and the Law of One Price
What must be true for the prices of securities X and Y in a capital market equilibrium?
They must be in a specific relationship to avoid potential arbitrage profits.
p.11
Term Structure of Interest Rates
What does the term structure of interest rates represent?
The series of spot rates r1, r2, ..., rt.
p.11
Bond Pricing and Interest Rate Relationship
How are spot rates related to bond prices?
Spot rates are used to discount cash flows, which determine bond prices.
p.6
Bond Pricing and Interest Rate Relationship
How do changes in interest rates affect the value of near-term vs. distant cash flows?
A change in interest rates has a modest impact on near-term cash flows but a much greater impact on distant cash flows.
p.8
Duration and Its Impact on Bond Prices
Why do investors track duration?
Because it measures how bond prices change when interest rates change.
p.7
Duration and Its Impact on Bond Prices
What is the formula for calculating duration?
Duration = (1 × PV(C1) + 2 × PV(C2) + ... + T × PV(CT)) / PV.
p.7
Bond Pricing and Interest Rate Relationship
What happens to the price of a bond when there is a 1% fall in yield?
The price of the bond increases.
p.14
Expectations Theory of the Term Structure
What does an upward-sloping term structure indicate?
Investors expect short-term interest rates to rise.
p.13
Arbitrage and the Law of One Price
What is the key lesson regarding the value of a dollar received at different times?
A dollar tomorrow cannot be worth less than a dollar the day after tomorrow.
p.15
Risk Factors in Long-term vs. Short-term Bonds
Why might investors demand higher returns for holding long-term bonds?
Due to the extra risk and volatility associated with long-duration bonds.
p.15
Expectations Theory of the Term Structure
What happens to the term structure when inflation is particularly uncertain?
It often becomes steeply upward-sloping.
p.2
Types of Bonds: Government vs. Corporate
What are Treasury bonds, notes, and bills?
They are U.S. government securities traded in the fixed-income market, with varying maturities.
p.8
Duration and Its Impact on Bond Prices
What happens to the duration of 3% bonds compared to the initial bond?
Duration increases to 6.40 years.
p.7
Duration and Its Impact on Bond Prices
How is the weight for each cash payment in duration calculated?
By dividing the present value of the cash flow received at that time by the total present value of the bond.
p.15
Term Structure of Interest Rates
What was the average return difference between long-term U.S. Treasury bonds and short-term Treasury bills from 1900 to 2017?
1.5 percentage points higher for long-term bonds.
p.7
Bond Cash Payments and Structure
What are the cash payments for the 9% bond in the example?
$90 annually for 6 years and $1,090 in the final year.
p.2
Bond Pricing and Interest Rate Relationship
Why is the yield to maturity less than the coupon payment for a bond sold at a premium?
Because the bond is purchased at a price higher than its face value, leading to a capital loss.
p.14
Expectations Theory of the Term Structure
What is the implication of a declining term structure?
Investors expect short-term rates to fall.
p.13
Arbitrage and the Law of One Price
What happens to arbitrage opportunities in well-functioning markets?
They are eliminated almost instantaneously by investors.
p.12
Arbitrage and the Law of One Price
What does the law of one price state regarding risk-free dollars?
Investors place the same value on a risk-free dollar regardless of whether it is provided by bond A, B, or C.
p.11
Present Value Calculation for Bonds
What is the significance of the discount factors in bond valuation?
They are used to calculate the present value of future cash flows from bonds.
p.6
Duration and Its Impact on Bond Prices
What does the average time to cash payments indicate about a bond's duration?
The average time to cash payments can be less than the bond's maturity, affecting its sensitivity to interest rate changes.
p.15
Expectations Theory of the Term Structure
What does the expectations theory imply about borrowing short-term when short-term rates are lower than long-term rates?
It implies that such strategies won't work because investors expect interest rates to rise.
p.8
Duration and Its Impact on Bond Prices
What does a 1% change in yield to maturity indicate for the bond price?
It should change the bond price by 5.47%.
p.9
Bond Cash Payments and Structure
How should yield and coupon values be entered in Excel functions?
As decimal values (e.g., 3% as .03).
p.5
Bond Pricing and Interest Rate Relationship
What occurs when the yield is lower than the bond's coupon rate?
The bond sells at a premium.
p.4
Bond Pricing and Interest Rate Relationship
How do long maturities of bonds change as they approach the final payment date?
They end up with short maturities.
p.3
Yield to Maturity and Its Calculation
What is the significance of the quoted yield for U.S. bonds?
It is usually quoted as twice the semiannual yields.
p.11
Present Value Calculation for Bonds
What is the purpose of discounting cash flows at spot rates?
To calculate the present value of future cash flows.
p.12
Present Value Calculation for Bonds
How is the price of a bond determined?
By adding the present values of each of its cash flows.
p.12
Term Structure of Interest Rates
How can the term structure of interest rates be measured?
Using the prices of stripped bonds.
p.8
Duration and Its Impact on Bond Prices
What is the formula for calculating the derivative of bond price with respect to yield?
dPV/dy = - modified duration.
p.10
Duration and Its Impact on Bond Prices
How is modified duration calculated for bonds with semiannual coupons?
By dividing Macaulay duration by the semiannual yield to maturity.
p.9
Bond Cash Payments and Structure
What is the significance of the 'basis' entry in the PRICE and YLD functions?
It is suggested to leave this blank.
p.10
Present Value Calculation for Bonds
How do you calculate the present value of a loan that pays $1 at the end of one year?
PV = 1 / (1 + r1), where r1 is the one-year spot rate.
p.10
Term Structure of Interest Rates
What was observed about U.S. short-term and long-term rates between September 1992 and April 2000?
Short-term rates rose sharply while long-term rates declined.
p.12
Yield to Maturity and Its Calculation
What is the relationship between yields to maturity and spot rates?
Yields to maturity are complex averages of spot rates.
p.12
Risk Factors in Long-term vs. Short-term Bonds
What is a potential anomaly in discount factors when different spot rates exist?
A dollar received the day after tomorrow may not necessarily be worth less than a dollar received tomorrow.
p.3
Bond Pricing and Interest Rate Relationship
What is the difference between the flat price and the dirty price of a bond?
The dirty price includes accrued interest, while the flat price does not.
p.12
Yield to Maturity and Its Calculation
What happens to yield to maturity as bond maturity increases?
The yield to maturity increases.
p.12
Term Structure of Interest Rates
What does a higher interest rate for longer lending periods indicate?
Investors require a higher interest rate for lending for longer periods.
p.2
Yield to Maturity and Its Calculation
What is the current yield on an investment if the coupon payment is €6.00 and the bond price is €144.99?
The current yield is 4.14%.
p.4
Present Value Calculation for Bonds
What is the formula for calculating the present value of bond cash flows?
PV = Σ (Cash Flow / (1 + r)^n).
p.10
Present Value Calculation for Bonds
What is the formula for calculating the present value of a loan that pays $1 at the end of two years?
PV = 1 / (1 + r2)^2, where r2 is the two-year spot rate.
p.2
Bond Pricing and Interest Rate Relationship
What happens to the value of a bond priced below its face value?
It sells at a discount, and investors look forward to a capital gain.
p.11
Yield to Maturity and Its Calculation
How does the maturity of a bond affect its yield to maturity?
Different maturities can lead to different yields due to varying cash flow structures.
p.11
Yield to Maturity and Its Calculation
What is the yield to maturity (YTM) in the context of bond valuation?
The single discount rate that equates the present value of future cash flows to the bond price.
p.11
Bond Pricing and Interest Rate Relationship
What is the relationship between coupon payments and bond pricing?
Bonds with the same coupon but different maturities will have different present values and yields.
