Bond Valuation and Management: A Comprehensive Guide
Bond Valuation and Management
Basic Concepts
1. What is the correct definition of a coupon rate?
B. Annual interest / Par value
2. What is the annual interest divided by the market price of a bond called?
C. Current yield
3. What is the yield to maturity (YTM)?
A. The discount rate that equates a bond’s price with the present value of the bond’s future cash flows.
4. What is a premium bond?
D. A bond with a market price that exceeds its par value.
5. What is a discount bond?
E. A bond with a face value that exceeds its market value.
6. What is the clean price of a bond?
C. The price of a bond, net of accrued interest.
7. What is the dirty price of a bond?
A. The invoice price, which includes accrued interest.
Callable Bonds
8. What is a callable bond?
D. A bond that can be redeemed by the issuer prior to maturity.
9. What does an issuer pay to redeem a bond prior to maturity?
D. Call price
10. What is a make-whole call provision?
C. A provision that requires the issuer to pay a price equal to the present value of the bond’s future cash flows when the bond is called.
11. What is a call protection period?
B. A period during which the issuer is prohibited from calling the bond.
12. What is the yield to call (YTC)?
E. The yield that a bond will earn given that it is bought back by the issuer at the earliest possible date.
Bond Risks
13. What is interest rate risk?
D. The risk that market interest rates may increase, causing the price of a bond to decline.
14. What is realized yield?
B. The rate of return an investor actually earns from owning a bond.
15. What is duration?
C. A measure of a bond’s sensitivity to changes in market interest rates.
16. What is the dollar value of an 01?
C. The change in a bond’s price caused by a change in yield to maturity of one basis point.
17. What is the yield value of a 32nd?
B. The change needed in the yield to maturity to cause a bond’s price to change by 1/32nd.
Bond Portfolio Management
18. What is a dedicated portfolio?
D. A bond portfolio created to fund a future cash outlay.
19. What is reinvestment rate risk?
A. The risk associated with investing a coupon payment at a rate that is lower than the bond’s yield-to-maturity.
20. What is immunization?
C. A strategy that involves creating a portfolio in a manner that minimizes the uncertainty of the portfolio’s maturity target date value.
21. What is price risk?
C. The risk that the bonds in a dedicated portfolio will decrease in value in response to an increase in interest rates.
22. What is dynamic immunization?
E. A strategy that involves periodically rebalancing a portfolio so that the duration continues to match the target date.
Bond Types and Characteristics
23. What is a straight bond?
D. A basic bond that has a face value of $1,000 and pays regular semiannual coupon payments.
24. Which of the following will increase if the coupon rate increases?
- I. Face value
- II. Market value
- III. Yield-to-maturity
- IV. Current yield
D. II, III, and IV only
25. What will decrease the current yield of a bond?
D. A decrease in the coupon rate.
26. What will occur if a bond’s discount rate is lowered?
A. The market price will increase.
Premium Bonds vs. Discount Bonds
27. Which statement is correct concerning premium bonds?
D. The yield to maturity is less than the coupon rate.
28. Which statement is correct concerning discount bonds?
A. The current yield is less than the yield to maturity.
29. Which statement applies to a par value bond?
D. The current yield, coupon rate, and yield-to-maturity are equal.
30. What characteristic must both a premium bond and a discount bond share, assuming no default risk?
C. Maturity value equal to a par value bond.
31. If a bond’s current yield is equal to its yield-to-maturity, what else must be true?
C. The bond can have any maturity date.
32. Which statement is true for a premium bond?
E. The coupon rate exceeds both the yield to maturity and the current yield.
Accrued Interest
33. Davis Industrial bonds have a current market price of $990 and a 6 percent coupon. The bonds pay interest semi-annually on March 1 and September 1. Assume today is January 1. How many months of accrued interest are included in the dirty price of these bonds?
D. Four
34. A bond pays interest semiannually on February 1 and August 1. Assume today is October 1. How many months of accrued interest are included in the clean price of this bond?
A. Zero
Yield-to-Maturity and Call Provisions
35. What does the yield-to-maturity assume?
E. All coupon payments are reinvested at the yield-to-maturity rate.
36. What increases the probability that a bond will be called?
D. Market interest rates decline.
37. Which statement is correct concerning a callable bond currently selling below face value, assuming no default risk and that the issuer only calls bonds when they can be refinanced at a lower interest rate?
B. The yield-to-maturity is presently more relevant to an investor than the yield-to-call.
Reinvestment Risk and Malkiel’s Theorems
38. Which statement is correct about reinvestment risk?
B. Reinvestment risk causes realized yields to differ from promised yields.
39. According to Malkiel’s theorems, what is the relationship between bond prices and bond yields?
A. They are inversely related.
40. Which combination of bond characteristics causes a bond to be most sensitive to changes in market interest rates?
- I. Low coupon rates
- II. High coupon rates
- III. Short time to maturity
- IV. Long time to maturity
C. I and IV only
41. How does the size of the change in a bond’s price react to a given change in the yield to maturity as the time to maturity increases?
D. Increases at a diminishing rate
42. Which statement is correct according to Malkiel’s Theorems?
E. For a given absolute change in a bond’s yield-to-maturity, a decrease in yield will cause a greater change in the bond’s price than will an increase in yield.
Duration and Immunization
43. What must be equal for two bonds if they are to have similar changes in their prices given a relatively small change in bond yields?
D. Duration
44. All else constant, which of the following will decrease the Macaulay duration of a straight bond?
- I. Reducing the coupon payment
- II. Shortening the time to maturity
- III. Lowering the yield to maturity
B. II only
45. Which statement is correct concerning Macaulay duration?
A. The duration of a zero-coupon bond is equal to the time to maturity.
46. What is modified duration?
B. Multiplied by (-1 × Change in the yield to maturity) equals the approximate percentage change in a bond’s price.
47. What should you do to immunize your portfolio?
C. Match bond durations to your target dates.
48. Last year, you created an immunized portfolio with an average maturity date of 14.5 years, a yield-to-maturity of 9.8 percent, and a duration of 9.6 years. According to the policy of dynamic immunization, how should you modify your portfolio now?
E. Modify the portfolio so the duration becomes 8.6 years.
49. What risk is dynamic immunization primarily aimed at reducing?
C. Reinvestment risk
Bond Calculations
50. A bond pays semiannual interest payments of $37.50. What is the coupon rate if the par value is $1,000?
Coupon rate = ($37.50 × 2) / $1,000 = 7.50 percent
51. A bond has a face value of $1,000 and a coupon rate of 5.5 percent. What is your annual interest payment if you own 8 of these bonds?
Annual coupon = $1,000 × .055 × 8 = $440
52. A bond has a par value of $1,000 and a coupon rate of 6 percent. What is the dollar amount of each semiannual interest payment if you own 6 of these bonds?
Semiannual coupon = [($1,000 × .06) / 2] × 6 = $180
53. A bond has a par value of $1,000, a market price of $1,012, and a coupon rate of 5.75 percent. What is the current yield?
Current yield = (.0575 × $1,000) / $1,012 = 5.68 percent
54. A 6.5 percent coupon bond has a face value of $1,000 and a current yield of 6.61 percent. What is the current market price?
Market price = (.065 × $1,000) / .0661 = $983.36