Finance Honors Tri 2 Test 1

Bonds and Bond Valuation + Stocks and Stock Valuation

What are bonds primarily used for in finance?

Bonds are long-term debt instruments that provide periodic interest income and return the principal amount at maturity.

What is the difference in pricing between premium, par, and discount bonds?

Premium bonds have a coupon rate greater than the yield to maturity and sell for more than par; par bonds have a coupon rate equal to the yield to maturity and sell at par; discount bonds have a coupon rate less than the yield to maturity and sell for less than par.

What is a zero-coupon bond?

A zero-coupon bond is a bond that does not pay interest over its life and is sold at a discount, paying the par value at maturity.

How is the Yield to Maturity (YTM) defined in bond terms?

YTM is the expected rate of return based on the price of the bond, considering its coupon payments and the time until maturity.

What are the two main types of bond markets?

The primary market, where bonds are issued for the first time, and the secondary market, where bonds are traded among investors.

What are bond ratings and why are they important?

Bond ratings assess the creditworthiness of a bond issuer, affecting the bond's price and the yield investors might expect.

What happens to bond prices when interest rates rise?

Bond prices fall when interest rates rise.

What characterizes common stock compared to bonds?

Common stock represents ownership in a company with rights to share in profits, whereas bonds are debt instruments with fixed returns.

What are the two forms of market efficiency?

Operational efficiency and informational efficiency, related to how well prices reflect available information and how trades are executed.

What is the difference between cumulative and non-cumulative preferred stock?

Cumulative preferred stock accrues unpaid dividends, while non-cumulative preferred stock does not.

What does the efficient market hypothesis (EMH) state?

The EMH suggests that security prices reflect all available information, making it impossible to achieve consistently higher returns than the market.

Common stock represents ownership in a company with rights to share in profits, whereas bonds are _______ instruments with fixed returns.

debt

What is preferred stock and how does it differ from common stock?

Preferred stock typically has fixed dividends and priority over common stock in asset distributions during liquidation.

What does a bond's coupon rate represent?

The coupon rate is the interest rate that the issuer pays to bondholders, calculated based on the bond's par value.

What is the purpose of a bond's maturity date?

The maturity date is when the bond issuer must repay the principal to bondholders and cease interest payments.

What is the capital structure of a company?

The capital structure is the mixture of debt and equity that a company uses to finance its operations.

How do dividends influence stock prices?

Dividends can positively influence stock prices as they indicate a company's profitability and financial health.

What is a callable bond?

A callable bond can be redeemed by the issuer before its maturity date, usually at a premium.

What is the impact of inflation on bonds?

Inflation erodes the purchasing power of fixed bond coupon payments, making them less attractive to investors.

What role do investment banks play in the bond market?

Investment banks underwrite bond issues, helping companies and governments raise capital through bond sales.

What is market capitalization in relation to stocks?

Market capitalization is the total market value of a company's outstanding shares, calculated by multiplying the share price by the number of shares.

How is the price-to-earnings (P/E) ratio used in stock valuation?

The P/E ratio compares a company's current share price to its earnings per share (EPS), helping investors assess if a stock is over or undervalued.

What is the concept of present value in bond valuation?

Present value is the current worth of a bond's future cash flows, discounted at the bond's yield to maturity.

What is the significance of the duration of a bond?

Duration measures a bond's sensitivity to interest rate changes, indicating how much the price of a bond is expected to fluctuate with interest rate movements.

What is the dividend discount model (DDM)?

The DDM values a stock based on the present value of its expected future dividends, assuming those dividends grow at a constant rate.

What factors influence the yield on a bond?

Bond yields are influenced by interest rates, credit ratings, inflation expectations, and the bond's maturity.

What is the difference between nominal and real interest rates?

Nominal interest rates do not adjust for inflation, while real interest rates reflect the purchasing power of money by accounting for inflation.

What role do credit ratings play in bond valuation?

Credit ratings indicate the risk of default on a bond, with higher ratings generally leading to lower yields and higher prices.

How does the yield curve relate to bond valuations?

The yield curve illustrates the relationship between interest rates and different maturities of bonds, influencing investor decisions and bond pricing.

What is a bond's call premium?

The call premium is the amount above the par value that a bondholder receives if a callable bond is redeemed before maturity.

Who issues bonds?

Bonds are issued by governments, municipalities, and corporations to raise capital.

How do you calculate the price of a bond?

The price of a bond is calculated as the present value of its future cash flows, which include coupon payments and the par value at maturity.

What are semiannual payments in bond terms?

Semiannual payments refer to bond interest payments that are made twice a year.

How do you convert Yield to Maturity (YTM) and PMT for semiannual payments?

To convert YTM and PMT to a periodic standard for semiannual payments, divide the annual YTM by 2 and multiply the annual coupon payment (PMT) by 1/2.

What is the difference between YTM, coupon yield, and coupon rate?

YTM is the overall return expected based on the current price, coupon yield is the annual coupon payment relative to the bond's price, and coupon rate is the bond's fixed interest payment divided by its face value.

Is par value the same as face value?

Yes, par value and face value refer to the same concept: the amount paid back to bondholders at maturity.

What are discount rates?

Discount rates are used to determine the present value of future cash flows by reflecting the opportunity cost of capital.

How do you calculate present value of cash flows?

Present value of cash flows is calculated by discounting future cash flows back to their current worth using the appropriate discount rate.

What is a zero coupon bond?

A zero coupon bond is a type of bond that does not make periodic interest payments and is sold at a discount to its face value.

What does it mean to receive no payment for a zero coupon bond?

Investors gain by purchasing the bond at a discount and receiving its full par value at maturity, without receiving interim payments.

What are bond ratings?

Bond ratings are evaluations of the creditworthiness of bond issuers, indicating the risk of default.

Which agencies provide bond ratings?

Bond ratings are typically provided by agencies such as Moody's, S&P Global Ratings, and Fitch Ratings.

What are the characteristics of common stock?

Common stock typically provides shareholders with voting rights, potential for capital appreciation, and variable dividends.

What is the difference between preferred stock and common stock?

Preferred stock generally has fixed dividends and priority over common stock in asset distribution, while common stock typically has voting rights but variable dividends.

What are the similarities and differences between stocks and bonds?

Both stocks and bonds are investment vehicles; stocks represent ownership in a company with variable returns, while bonds are debt instruments with fixed returns and priority in asset distribution.

What are the primary and secondary markets?

The primary market is where new securities are issued directly to investors, while the secondary market is where existing securities are traded among investors.

What are some shortcomings of the dividend discount model (DDM)?

The DDM assumes dividends grow at a constant rate and may not account for companies that do not pay dividends or inconsistent dividend payments.

What are the different types of dividend models?

Common types of dividend models include the Gordon Growth Model, the Two-Stage Dividend Model, and the H-Model, each varying in complexity and assumptions about future growth.

What is preferred stock?

Preferred stock is a type of equity security that usually has fixed dividends and has a higher claim on assets than common stock in the event of liquidation.

What does it mean that preferred stock is valued at more?

Preferred stock may be valued at more due to its fixed dividend payments and priority in asset claims, making it more attractive to certain investors.

What are operational and informational efficiency in markets?

Operational efficiency relates to how smoothly trades are executed, while informational efficiency refers to how quickly and accurately prices reflect all available information.