Return of the Bond, not Jedi or even James Bond
One who delays command over resources for his/her own purposes, making early command over them available to whomever acquires it is a _______.
saver (or lender)
The price of bonds (and therefore the interest rate on bonds) is set _______.
by supply and demand.
A downward sloping yield curve is a good predictor of _______.
recession
Why is the valuation of preferred stock similar to valuing a perpetuity?
Because the dividend is a fixed amount.
What is the current yield of a 10-year 12% coupon bond with a face value of $1000 and currently selling at $950?
ic = C/P
ic = 120 / 950 = 12.6%
Who is the buyer and who is the seller in the loanable funds market?
The buyer of the use of LF is the BORROWER.
The seller of the use of LF is the SELLER.
The risk structure of interest rates explains differences in yields across securities with similar _______.
maturities
If Jackson Brothers currently pays $4 in annual dividends and the dividend is expected to grow at 5% per year forever, what value would you place on a share of Jackson Brothers stock if you required a 12% return?
P = [D0 (1 + g) ] / (r - g)
P = [$4 (1 + .05)] / (0.12 - 0.05)
P = $60
Adam purchased a $1,000 face value bond with a 10% coupon rate and 3 years to maturity. The bond makes annual interest payments. If Adam paid $1030.00 for the bond, how would you find its yield to maturity?
P = PV = [C/1 + i] + [C/(1 + i)2] + [C/(1 + i)3] + [F/(1 + i)3]
$1,030 = $100/(1 + i) + $100/(1 + i)2 + $1100/(1 + i)3
Solve for i.
What happens in the market for bonds when the aggregate wealth in the economy falls? What does that do to the interest rate on those bonds?
The demand for bonds decreases and the price of bonds falls.
The interest rate falls.
If the 1-year Treasury bond yield is 2% and the yield on a 1-year corporate bond is 5%, that 3% difference is the _______.
default risk premium
the information assumed to be incorporated in the asset prices
You intend to purchase a 4 year, $1,000-par-value bond that has a coupon rate of 9%. If your required return is 10%, what is your value of this bond?
P = PV = [C/1 + i] + [C/(1 + i)2] + [C/(1 + i)3] + [C/(1 + i)4] [F/(1 + i)4]
= [90/1.1] + [90/1.12] + [90/1.13] + [1090/1.14]
What happens in the market for loanable funds when investors expect higher inflation in the future?
Investors prefer the price protection offered by real assets during times of higher inflation so the Supply of loanable funds will decrease. Borrowers want to borrow more when higher inflation is expected because they can spend the money when purchasing power is greater. This increases the Demand for loanable funds.
Both of these changes have the effect of increasing the interest rate on the use of loanable funds.
If you become more risk averse, your certainty equivalent payment will _______.
fall
At the beginning of the year you buy a share of IBM stock for $120. If during the year you received a dividend of $2.50 and sold the stock at the end of the year IBM stock is selling for $130/share, what is your rate of return from investing in the stock?
You received a $2.50 dividend and $10 capital gain on your investment during the year. Your rate of return, calculated as a percentage of your purchase price of $120 is:
(($2.50 + $10.00)/$120) = .1042
10.42%
Last year you bought a $1,000 coupon bond maturing in four years. You paid face value. It has a 10% coupon rate. Today you sell the bond for $1150. What is your rate of return on this bond over the last year?
coupon payments received + capital gain/loss
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Purchase price of the bond
= ($100 + $1150) / $1000 = $1250/$1000
= 1.25
Rate of return = 25%
What happens in the bond market when the expected profitability of capital increases?
An increase in the expected profitability of capital makes borrowing for capital purchases more attractive. The Supply of bonds increases, lowering the price of bonds.
When and why do we typically see a "flight to quality" in the bond market?
The WSJ has a stock-picking contest where staff columnists and Wall Street fund managers each pick 24 stocks. In a recent year, of the columnists' stock picks "more picks lost money than made money." But the columnists' picks still performed better than the picks of the fund managers. Shouldn't well-informed fund managers be able to choose more stocks that will increase in price than decrease in price? Explain.
On average, it should not be possible to consistently pick winning stocks. If the stock market is efficient, all available information is included in stock prices, so the ability of journalists or fund managers to pick winning stocks is more about luck than about knowledge. However, well-informed managers and financial journalists are, picking stocks that will rise in value over the year is largely a matter of luck (assuming that no one has inside information).