FINC 335 - Investments: Bond Prices and Yields- Topic 10

These flashcards cover key concepts related to bond prices and yields from the FINC 335 lecture, facilitating study and review.

What are the main features of bonds?

Bonds can be issued by governments, corporations, and foreign governments, have various terms to maturity, can be premium, discount, or par bonds, and have distinct coupon rates.

What is Yield to Maturity (YTM)?

The discount rate that makes the present value of all cash flows equal to the bond price, or the internal rate of return on a bond.

What is a premium bond?

A bond that sells for more than its face value.

What distinguishes a discount bond?

A bond that sells for less than its face value.

What is the coupon rate?

The total annual interest payment per dollar of face value of the bond.

How does the price of a bond relate to its YTM?

If the YTM is higher than the coupon rate, the bond price is lower than face value (discount); if lower, the bond price is higher than face value (premium).

What is a zero-coupon bond?

A bond that does not pay periodic interest payments; instead, it is sold at a discount to its face value and pays the face value at maturity.

Describe the yield curve?

A graphical representation of the relationship between interest rates and the time to maturity for bonds.

What factors affect yield spreads?

Risk factors like credit ratings, default risk, and tax-exempt features that influence the interest rate differences between various bond sectors.

What is the significance of the Fisher Equation?

It relates nominal interest rates to real interest rates and inflation, showing how they influence bond pricing.

Define behavioral finance.

A field of finance that examines psychological influences on people's financial behavior.

What is the difference between nominal and real interest rates?

Nominal rates are unadjusted for inflation, while real rates are adjusted for the effects of inflation.

Explain the term 'Covenants' in bond contracts.

Legal agreements that impose certain restrictions or obligations on the issuers of the bonds.

What type of bond is affected by inflation?

Inflation-indexed bonds, which adjust interest payments based on inflation rates.

What is the relationship between interest rates and bond prices?

As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise.

What happens to bond prices over time?

Bond prices tend to converge towards par value as they approach maturity.

What is realized return?

The actual return on an investment, which may differ from the YTM based on market conditions and reinvestment rates.

How is the price of a bond calculated?

It is calculated as the present value of future cash flows, including coupon payments and face value at maturity.

What is a Yankee bond?

A bond issued in the U.S. by a foreign entity, typically denominated in U.S. dollars.

What is the coupon payment for a bond if the face value is $1000 and the coupon rate is 8%?

The coupon payment is $80, calculated as 8% of $1000.

What is the role of credit risk in bond pricing?

Higher credit risk generally leads to higher yields demanded by investors, affecting the bond's price.

How do market yields affect the return on investment in bonds?

Market yield fluctuations can lead to changes in bond prices, thereby affecting realized returns when sold before maturity.

Describe a callable bond.

A bond that can be redeemed by the issuer prior to its maturity date at a specified price.

What is the shape of a typical yield curve?

Most commonly, a yield curve is upward sloping, indicating higher yields for longer maturities.

What happens when the YTM rises?

The price of the bond will typically fall as the bond's fixed coupon payments become less attractive.

How do liquidity premiums affect bond pricing?

Bonds with lower liquidity may require higher yields to attract investors, leading to lower prices.