What is the formula to find a present value of the principal
Future Value of Principal
PV= (1+r)?
r=discount rate
n= # of compounding periods
What is the formula to find a present value of annuity (income stream)
? 1- __1__ ?
(1+r)?
__________
APV=C x r
? ?
c=payment (the value of one coupon payment)
r=discount rate
n= # of compounding periods
What is the formula to find a present value of a bond
The formula for PV of principal and the formula for the PV of an annuity added together
What is the formula to find a current yield of a bond?
Current Yield
= Annual Cash Flow (coupon rate)
------------------------------------------ x 100
Current Market Price
What is the formula for finding a treasury bill yield?
100-price x 365 x 100
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price term
What is the formula for calculating the Yield to Maturity (YTM) on a bond?
Interest Income +/- Annual price change *
------------------------------------------------------ x 100
(Purchase Price +100) �2
* annual price change is calculated as:
Maturity Price - Purchase Price
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# of compoundi
What happens to the real rate of return during a recession?
Real interest rates tend to be cyclical, rising during periods of economic growth and falling during recessions.
The supply of and demand for funds are key determinants of the real rate. Demand for funds increases when business conditions improve and the
What happens to an investor's return when inflation is higher than expected?
If the inflation rate is higher than expected, the investor's real rate of return will be lower than expected.
An unexpected change in the inflation rate also affects the real rate of return. An investor lending money will demand an interest rate based on
If investors expect inflation to be 3% next year and the nominal interest rate on a GIC is 5%, what is the real rate of return on this investment?
For this GIC, the real return is 2%, calculated as 5% - 3%.
The real interest rate accounts for the negative effects of inflation.
If a financial institution has a preference for a specific maturity term sector, which of the following term structure theories is it following?
a)Expectations theory
b)Market segmentation theory
c)Liquidity preference theory
d)Rational expectations theor
b) A financial institution with a preference for a specific maturity term is adhering to the market segmentation theory.
According to the market segmentation theory, investors have specific maturity preferences, thus short-term and long-term maturity rang
You believe that the Bank of Canada will begin to tighten monetary conditions this year. According to the expectations theory, where would you expect long-term rates to be in relation to short-term rates?
a)Higher than short-term rates
b)Lower than short-
a)You would expect long-term rates to be higher than short-term rates.
The expectations theory states that investors' demand for higher yields on long-term maturities reflects their expectation of rising future short-term rates.
When the Bank of Canada ti
What does the normal shape of the yield curve say about interest rates?
a)Short-term rates are lower than long-term rates
b)Long-term rates are lower than short-term rates
c)Short-term and long-term rates are equal
d)Medium-term rates are higher than shor
a)he normal shape suggests that short-term rates are lower than long-term rates.
The most common shape for the yield curve is the normal curve. This shape occurs when long-term yields are higher than short-term yields and is thought to reflect the risk pr
Several theories have been developed to explain the shape of the yield curve:
What are they explain each
--liquidity preference-Because there is greater interest rate risk associated with long-term bonds, investors generally prefer short-term bonds because of their liquidity. Investors will consider buying long-term bonds only if long-term yields are suffici
What expectations are implicit in a downward sloping yield curve?
a)Investors expect rates to fall in the future.
b)Investors expect rates to rise in the future.
c)Investors expect rates to rise then fall.
d)Investors expect rates to remain fairly stable.
a)A downward sloping yield curve, where short-term rates are higher than long-term rates, indicates that investors expect interest rates to decline in the future. They require a high short-term rate, perhaps because current inflation rates are high, but a
Which of the following bond theorems are correct?
i) Bond prices move inversely to interest rates.
ii) The longer the term to maturity the greater the interest rate risk.
iii) Bonds with low coupon rates have more price volatility than bonds with high cou
d)There are some conventional rules regarding the price action of fixed-income securities. Each of these rules is explained separately below.
First it must be understood that there is very little difference between interest rates and yields. After all, ea
If an investor expects market interest rates to decline, what type of bonds should she buy?
a)Short-term, low coupon.
b)Long-term, low coupon.
c)Long-term, high coupon.
d)Short-term, high coupon.
b)If market interest rates decline, bond prices will increase and bondholders will earn capital gains. The investor should attempt to maximize the potential capital gain by purchasing bonds that are more volatile. Long-term bonds are more volatile than sh
Why is the normal slope of the yield curve upward sloping to the right?
a)Yields increase with time to reflect the increased risk of longer terms to maturity.
b)Bond prices increase as the term to maturity of the bond increases.
c)Yields are higher for bo
a)Bond yields normally increase as the term to maturity increases to reflect the risk of holding a bond with a longer term. The actual slope of the yield curve can vary significantly depending on economic conditions and other factors such as supply and de
What is the settlement period for Government of Canada bonds with terms to maturity of three years or less?
a)Same day
b)Second clearing day after the transaction takes place.
c)Third clearing day after the transaction takes place.
d)First clearing day on
b)Government of Canada (GoC) Treasury Bills are settled the same day. All GoC Bonds and GoC Guaranteed Bonds with a term to maturity of three years or less, or to the earliest call date, where a transaction is completed at a premium, are settled the secon
What must an investor pay when purchasing a bond?
a)The bond's market price plus interest accrued since the last interest payment.
b)The market price of the bond.
c)The market price of the bond as of the settlement date.
d)The bond's market price less int
a)When a securities transaction takes place, the change in legal ownership of the securities is effective immediately. However, payment for purchased securities does not have to be made until some time later, and delivery of sold securities also does not
DDD Co. Inc. has an outstanding 12 year bond with a coupon of 8.75%. The financial press is quoting it with a yield of 6%. What does this imply with respect to the bond?
a)The price of the bond will be below par.
b)The price of the bond will be at par.
c)
c)The most important bond pricing relationship to understand is the inverse relationship between bond prices and interest rates (or bond yields)� as interest rates rise, bond prices fall and as interest rates fall, bond prices rise. So if the yield of the
Sonoma is convinced that interest rates are going to drop. She wishes to buy a bond, hold it until rates have dropped, then sell it to earn a capital gain. Recommend a bond for her to purchase.
a)A 6% 10 year bond.
b)A 6% 8 year bond.
c) A 6 month T-bill.
a)Longer-term bonds are more volatile in price than shorter-term bonds. If she wishes the price to move up more, she should choose the longer term bond.
Neta has read that interest rates are expected to go up. She currently owns 4 bonds and is thinking of selling one before this happens. Recommend a bond she should sell?
a)A 6% 8 year bond with a duration of 7.
b)A 7% 9 year bond with a duration of 8.
c)5
d)Duration is a measure of the sensitivity of a bond's price to changes in interest rates. It is defined as the approximate percentage change in the price or value of a bond for a 1% change in interest rates. The higher the duration of the bond, the more
The inflation rate is expected to be 3% next year. Sharif buys a bond at par with a 7% coupon. Calculate his real rate of return?
a)3%
b)4%
c)7%
d)10%
b)Because inflation reduces the value of a dollar, the return that is received, known as the nominal rate, must be reduced by the inflation rate to arrive at the actual or real rate of return.
Real Rate = Nominal Rate - Inflation Rate.
JVV Inc. is about to sell a new issue of debt. The maturity of the debt is expected to be 20 years. Interest rates in the market place are as follows:
Government of Canada 10 year bonds are yielding 4%.
Government of Canada 20 year bonds are yielding 8%.
d)The appropriate discount rate is chosen based on the risk of the particular bond. The discount rate can be estimated by the yields currently applicable to bonds with similar coupon, term and credit quality. These yields are determined by the marketplace