Question 1

The maturity date of a bond is...&#10;A)The date on which the principal amount of a bond is to be paid in full.&#10;B)The date on which the bond expires.&#10;C)The date on which the bond's interest is paid.&#10;D)The date on which the bond is issued.

Accepted Answer

The Maturity date of a bond is the date on which the principal amount of the bond is to be paid in full.
Key Takeaway: The bond issuer agrees to pay the investors the original sum loaned at the bond's maturity date. It is common however, that not all bonds reach their maturity, as when the issuer retires the bond before it matures.

Question 2

A bond is often referred to as being short-, medium- or long-term depending on its maturity. What type of bond is a two-year bond?&#10;A)A short-term bond.&#10;B)A medium-term bond.&#10;C)An intermediate-term bond.&#10;D)A long-term bond.

Accepted Answer

Generally, a bond that matures in one-to-three years is referred to as a short-term bond. A medium-term bond generally matures in four-to-10 years, and a long-term bond matures in more than 10 years.
Key Takeaway: Whatever the duration of a bond, the bond issuer fulfills his debt obligation when the bond reaches its maturity date. At this time, the final interest payment and the original sum investors loaned (the principal) are paid.

Question 3

Tom is thinking to buy bonds. However, he is debating between long-term bonds and short-term bonds. What factors will influence his decision?&#10;A)His available funds.&#10;B)His risk preferences.&#10;C)The relative yields between short-term and long-term bonds.&#10;D)His personal patience level.

Accepted Answer

The choice between whether to invest in short-term or long-term bonds depends upon the relative yields between them. If yields on long-term bonds are historically low relative to yields on short-term bonds, greater returns may be available at shorter maturities.
Key Takeaway: As investors are rational, they will choose investments that yield more returns, regardless of the maturity.

Question 4

A bond's yield to maturity (YTM) rate is the rate of return you receive if you hold a bond until it matures and reinvest all the interest payments at the YTM rate. What factors determine the YTM of a bond?

A)A bond's term to maturity.
B)Uncertainty in price.
C)Risk.
D)All of the above.

Accepted Answer

The yield to a bond depends on all of these factors: a bond's term to maturity, the time between its issue date and its maturity date, uncertainty in price, inflation, and risk. Therefore, different bonds have different yields.
Key Takeaway: Depending on different values of different bonds, there are some variants of YTM:
- Yield to call: It is calculated similarly with YTM but when a bond is callable, the cash flow is shortened.
- Yield to put: It is the same as yield to call, but the bond holder has the option to sell the bond back to the issuer at a fixed price on a specified date.
- Yield to worst: It is the lowest yield of all kinds, when the bond is callable or exchangeable.

Question 5

If Tom sells a bond before it matures, he will most likely catch the bond between coupon payment dates. Then what will he get?&#10;A)He will only get the principal value of the bond.&#10;B)He will only get the face value of the bond.&#10;C)He will get the price of the bond plus the accrued interest that the bond has earned up to the sale date.&#10;D)He will get the price of the bond pus the accrued interest that the bond earns until its maturity date.

Accepted Answer

If he sells the bond, he is entitled to the price of the bond plus the accrued interest that the bond has earned up to the sale date.
Key Takeaway: Accrued interest is the interest that adds up each day between coupon payments. It guarantees Tom compensation for the period of time he has owned the bond.

Question 6

Tom is thinking of buying zero-coupon bonds. What are these bonds?&#10;A)They are bonds that don't make regular interest payments.&#10;B)They are bonds that mature within a year.&#10;C)They are bonds whose accrued interests add up to more than 0.&#10;D)They are bonds that have a special number zero to distinguish them from normal bonds.

Accepted Answer

Zero coupon bonds are bonds that don't make regular interest payments.
Key Takeaway: If Tom buys the zero-coupon bonds he doesn't get interest payments, but he buys the bond at a discount from the face value of the bond. He will be paid the face value when the bond matures. Typically, the face value is the result of the accrual of interest on the original price paid.

Question 7

Suppose two bonds are trading in the secondary market. They have the same maturity date and similar credit quality, but one has a nominal yield of 4% while the other has one of 8%. What does this really tell you about the two bonds?

A)One is more attractive than the other.
B)Two bonds must be different in values.
C)Two bonds must have been issued by different lenders.
D)Two bonds must have been issued at different times.

Accepted Answer

Two bonds must have been issued at different times. One was issued when interest rates were around 4%, while the other was issued when interest rates were around 8%.
Key Takeaway: The nominal yield to a bond is the sum of total coupons paid each year, divided by the face value of the bond. The higher the nominal yield to a bond is, the higher the coupons are.

Deck 2: Bond