The rate of return on a bond

The rate of return on a bond

(5-1)
Define each of the following terms:

Bond; Treasury bond; corporate bond; municipal bond; foreign bond

Par value; maturity date; coupon payment; coupon interest rate

Floating-rate bond; zero coupon bond; original issue discount bond (OID)

Call provision; redeemable bond; sinking fund

Convertible bond; warrant; income bond; indexed bond (also called a purchasing power bond)

Premium bond; discount bond

Current yield (on a bond); yield to maturity (YTM); yield to call (YTC)

Indentures; mortgage bond; debenture; subordinated debenture

Development bond; municipal bond insurance; junk bond; investment-grade bond

Real risk-free rate of interest, ; nominal risk-free rate of interest,

Inflation premium (IP); default risk premium (DRP); liquidity; liquidity premium (LP)

Interest rate risk; maturity risk premium (MRP); reinvestment rate risk

Term structure of interest rates; yield curve

“Normal” yield curve; inverted (“abnormal”) yield curve

(5-2)
“Short-term interest rates are more volatile than long-term interest rates, so short-term bond prices are more sensitive to interest rate changes than are long-term bond prices.” Is this statement true or false? Explain.

(5-3)
The rate of return on a bond held to its maturity date is called the bond’s yield to maturity. If interest rates in the economy rise after a bond has been issued, what will happen to the bond’s price and to its YTM? Does the length of time to maturity affect the extent to which a given change in interest rates will affect the bond’s price? Why or why not?

(5-4)
If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.

(5-5)
A sinking fund can be set up in one of two ways. Discuss the advantages and disadvantages of each procedure from the viewpoint of both the firm and its bondholder