Chapter 6: Valuing Bonds
When the interest rate is higher than a bond’s coupon rate, the bond will be priced at: less than
face value
Ex. A 5 year, $1000 bond offering a 10% coupon. If the interest rate is higher than the coupon
rate – for example, if the interest rate is 12%, the PV of the bond would be: $100/(1.12)1 +
$100/(1.12)2 + $100/(1.12)3 + $100/(1.12)4 + $100/(1.12)5 = $927.90 – a lower price than the
$1000 face value.
The return on a bond that sells at a discount is greater than the current yield.
Which of the following sell bonds? State and local governments; U.S. treasury; corporations
The price of a bond can be quoted as a percentage of face value.
Real interest rates depend on which of the following? Supply of savings; demand for new
investment
The interest payments to the bondholder are called the coupon
The real interest rate on the Treasury bond depends on which of the following? Nominal
interest rate; rate of inflation
The risk in bond prices due to fluctuations in interest rates is known as interest rate risk.
When the interest rate is lower than the coupon rate on a bond, the price of the bond will be:
higher than face value.
Which of the following are steps bondholders can take to minimize default risk? Protective
covenants; seniority; security.
If interest rates rise, the rate of return on a bond will be less than the yield to maturity.
Conditions imposed on borrowers to protect lenders from unreasonable risk are known as
protective covenants.
Even when the yield curve of a long-term bond is upward sloping some investors, prefer short-
term bonds. Which of the following reasons would explain why this statement is true? Short-
term investors can profit if interest rates rise; prices of long-term bonds fluctuate more than
prices of short-term bonds.
A $100,000 bond quoted at 120% will sell for $120,000 ($100,000 x 1.20 = $120,000).
You pay $1,200 for a bond and receive annual income of $100. The current yield on the bond is
8.33% (100/1200=.0833).
Bonds rated Baa or above by Moody’s or BBB or above by Standard & Poors are known as
investment grade bonds.
A graph of the yield curve shows the bond yield to maturity on the vertical axis and the time to
maturity on the horizontal axis.
A company issues a $5,000 bond, maturing in 5 years with a coupon rate of 4% paid
semiannually. The correct interest rate is 2%. What is the price the bond will sell for? $5,473.57
What is the term used in finance to represent simple, standard, and common? Plain vanilla
The additional yield on a bond that investors require for bearing default risk is known as default
premium.
The total income per period per dollar invested is known as the rate of return.
If the nominal rate of interest is 10% and the rate of inflation is 3%, the real interest rate is 6.8%
(1.10/1.03 = .00679).
When the coupon rate of a bond is equal to the current interest rate, the bond will sell for face
value.
The discount rate that makes the present value of the bond’s payments equal to its price is
known as the yield to maturity.
Motor’s Corporation sold 6 year bonds for $1,072.62, with a face value of $1,000 and a coupon
rate of 8%. The annual yield to maturity is 6.5%
Marley corporation’s bonds have four years left to maturity. Interest is paid annually, and the
bonds have a $1,000 par value and a coupon rate of 5%. If the price of the bond is $841.51, the
yield to maturity is 10%.
Bonds rate Ba or below by Moody’s or BB and below by S & P are known as junk bonds.
