Chapter 7

Question 1

Bond

Answer 1

Debt instrument in which an investor loans a certain amount of money (principal) to a borrower for a defined period of time at which point (maturity date) the principal is returned. The borrower (issuer) pays a fee (interest) on the amount borrowed in the form of coupon payments

Question 2

Par Value

Answer 2

Also called face amount, represents amount of principal paid at maturity

• Assume 1000-dollar base amount

Question 3

Issue Date

Answer 3

Date when the bond was originally issued and priced

Question 4

Settlement Date

Answer 4

Date when cash and securities are exchanged

Question 5

Maturity Date

Answer 5

Date when bond must be repaid

Question 6

Coupon Interest Rate

Answer 6

Stated interest rate paid by the issuer

• Multiply by par value to get dollar payment of interest

Question 7

Fixed Rate Bond

Answer 7

Interest state stays fixed over life of bond

Question 8

Yield to Maturity (YTM)

Answer 8

Rate of return earned on a bond if held until maturity

Question 9

Zero Coupon Bond

Answer 9

Bond issued at a discount which pays no coupon

• 0 Cash Flow

Question 10

Floating Rate Bond

Answer 10

A bond whose interest rate fluctuates based on a general level of interest rates or a benchmark rate

Question 11

Amortization

Answer 11

Bonds that pay periodic principal payments over life of bond
Ex/ Student loans, mortgages, car loans

Question 12

Indexed Bonds (Linkers)

Answer 12

Bonds whose interest rate is tied to level of inflation

Question 13

Call Provisions

Answer 13

Bonds that give the issuer the right to redeem bonds under certain conditions prior to the maturity date

• Typically, less expensive for investors

Question 14

Puttable Bonds

Answer 14

A bond that allows the investor to sell the bond back to the issuer at a prearranged price prior to the maturity date

• Typically, more expensive for the investor

Question 15

Interest Payments

Answer 15

Similar to receiving a fixed annuity over a given period of time where payment is called a coupon

Question 15

Sinking Fund

Answer 15

A provision in a bond contract requiring issuer to redeem a certain portion of the bond issue each year

Question 16

Principal Payment

Answer 16

Return of principal at maturity

• similar to lump sum payment in future

Question 17

Price of a Bond

Answer 17

The price of a bond is equal to the present value of all its future cash flows, discounted at an interest rate

Question 18

Lower yield to maturity ___________ present value price

Answer 18

Increases

Question 19

Higher yield to maturity ____________ present value

Answer 19

Decreases

Question 20

Positive Convexity

Answer 20

A bond’s price rises faster when interest rates fall than when interest rates rise

Question 21

Discount Bonds

Answer 21

A bond that sells for less than its par value

Question 22

Premium Bonds

Answer 22

A bond that sells for greater than par value

Question 23

Price Risk

Answer 23

Interest rates and bond prices have an inverse relationship, as interest rates fall, the price of the bond rises. As interest rates rise, the price of the bond falls.

Question 23

Time to Maturity and Price Risk

Answer 23

The risk that a bond's price will change when market interest rates change - Longer-term bonds are more sensitive to interest rate changes than short-term bonds

Question 23

Yield Curve Risk

Answer 23

The risk of experiencing an adverse shift in market interest rates associated with investing in a fixed income instrument. - Associated with either a flattening or steepening of the yield curve

Question 24

Duration Risk

Answer 24

First order estimate of how the price of a bond will change given a change in interest rates

Question 25

Convexity risk

Answer 25

Second order estimate of how the price of a bond change given a change in interest rates - Measures the sensitivity of the bond's duration

Question 26

Reinvestment Risk

Answer 26

The concern that a decline in interest rates will lead to a decline in income from a bond portfolio

Question 27

Call Risk

Answer 27

The risk faced by a holder of a certain callable bond that the issuer will take advantage of the bond's call feature and redeem he issue prior to maturity

Question 27

Repayment Risk

Answer 27

When a homeowner fully or partially repays a mortgage

Question 28

Yield to Call

Answer 28

The return you earn on a callable bond if the issuer pays it off early at the call date, rather than waiting until maturity

Question 29

Call Price

Answer 29

The price at which issuer may redeem price -The call price is usually at premium price to the bond

Question 29

Call Date

Answer 29

The date at which the bond is redeemed early

Question 30

Call Schedule

Answer 30

The complete list of call dates and call prices for a bond

Question 31

Default Risk

Answer 31

The risk that the issuer is unable to make schedule interest and/or principal payments - If the issuer defaults, the investor almost always receives less cash flow than promised in the bond contract

Question 32

Credit Risk

Answer 32

The risks associated with changes in the issuer's financial strength over the investment horizon

Question 33

Event Risk

Answer 33

Any unforeseen event associated with an issuer that can affect its credit quality

Question 34

Inflation Risk

Answer 34

The risk that the purchasing power of the cash flows associated with a bond will be eroded due to a general rise in prices - the longer the maturity on the bond, the greater the risk

Question 35

Liquidity Risk

Answer 35

The risk that there may not be an active secondary market for a bond that would enable an investor to sell a bond near its intrinsic value prior to the maturity date

Question 36

Volatility Risk

Answer 36

The risk associated with increases in interest rate volatility that can negatively impact the value of certain bonds

Question 37

Exchange Rate Risk

Answer 37

The risk associated with fluctuations in the value of foreign currencies relative to the home currency of the bond investor

Question 38

Sovereign Risk

Answer 38

The risks associated with the creditworthiness and likelihood of default by a sovereign government on its debts