Chap 10 Bond Prices and Yields

Concept Questions

1. Premium (par, discount) bonds are bonds that sell for more than (the same as, less than) their face or par value.

2. The face value is normally $1,000 per bond. The coupon is expressed as a percentage of face value (the coupon rate), so the annual dollar coupon is calculated by multiplying the coupon rate by $1,000. Coupons are normally paid semi-annually; the semi-annual coupon is equal to the annual coupon divided by two.

3. The coupon rate is the annual dollar coupon expressed as a percentage of face value. The current yield is the annual dollar coupon divided by the current price. If a bond’s price rises, the coupon rate won’t change, but the current yield will fall.

4. Interest rate risk refers to the fact that bond prices fluctuate as interest rates change. Lower coupon and longer maturity bonds have greater interest rate risk.

5. For a premium bond, the coupon rate is higher than the yield. The reason is simply that the bonds sells at a premium because it offers a coupon rate that is high relative to current market required yields. The reverse is true for a discount bond: it sells at a discount because its coupon rate is too low.

6. A bond’s promised yield is an indicator of what an investor can expect to earn if (1) all of the bond’s promised payments are made and (2) market conditions do not change. The realized yield is the actual, after-the-fact return the investor receives. The realized yield is more relevant, of course, but it is not knowable ahead of time. A bond’s calculated yield to maturity is the promised yield.

7. The yield to maturity is the required rate of return on a bond expressed as a nominal annual interest rate. For noncallable bonds, the yield to maturity and required rate of return are interchangeable terms. Unlike YTM and required return, the coupon rate is not used as the interest rate in bond cash flow valuation, but is a fixed percentage of par over the life of the bond used to set the...