Multiple inv

• Convertible bonds


  • When the stock's market price is at or above its conversion price, the value of a convertible is driven by the price behavior of the underlying common stock
  • When the stock's price is well below the conversion price, convertibles behave more like conventional bonds and the price is driven by market interest rates
• Bonds


  • They provide income and stability to an investment portfolio
  • The bond market has occasionally outperformed the stock market for several years at a time
  • Bondholders usually do not have capital gains when interest rates are rising
  • Bond prices are not stable over any five- to ten-year period
  • The income stream from bonds is stable and predictable
  • Bonds are not immune from most of the types of risk that affect stocks
• Advantages of owning bonds

  • Diversification properties
  • Current income
  • Lower risk than stocks
• Types of risk that affect bonds

  • Call risk
  • Business risk
  • Purchasing power risk
  • Liquidity risk
• Statements about bond ratings

  • They have a greater impact on the price and yield of junk bonds than on investment grade bonds
  • They provide investors with a convenient way to assess the relative risk of various bond issues
  • They have a significant effect on a bond's price and yield
• Factors included in the rating analysis of a corporate bond

  • The issue's indenture provisions
  • The liquidity position of the issuing company
  • The issuing company's relative debt burden
  • The stability of the company's earnings
• Types of call features

  • Freely callable (the bond can be retired at any time)
  • Noncallable (the bond cannot be called)
  • Deferred call (can be called, but only after a certain specified period)
• Equipment trust certificates


  • Typically used to raise funds for purchasing airplanes and railroad engine
  • Generally offer above-average yields
• Collateralized mortgage obligations (CMOs)

  • All bondholders receive a pro-rata share of all interest payments
  • CMOs are derivative securities created from mortgage-backed bonds
  • All principal payments are paid to the shortest remaining tranche
• High-yield bonds


  • Junk bonds with highly unpredictable rates of return
  • Issuing corporation usually has an excessive amount of debt
  • Possess a high level of default and market risk
  • Often subordinated debentures
• Taxable bonds from lowest yielding to highest yielding

  • U.S. Treasury bonds
  • Agency bonds
  • Corporate bonds
• Factors that will tend to cause the risk free rate to rise

  • Increase in the federal budget deficit
  • Increase in the level of economic activity
• Factors that influence short-term interest rates on government securities

  • Federal Reserve actions
  • Expected future inflation
  • The real rate of return
• Factors affecting the yield curve

  • Lender preferences
  • Inflationary expectations
  • Liquidity preferences
  • Short- and long-term supply and demand conditions
• Information needed to determine the appropriate value of a bond


  • Required rate of return
  • Time to maturity
  • Frequency of interest payments
  • Coupon rate
• Statements concerning yield-to-maturity (YTM)


  • YTM considers both interest income and price appreciation
  • YTM is a compounded rate of return
  • YTM assumes all interest payments are reinvested at the YTM rate
• Statements about a $1,000, 6% annual coupon bond selling for $1,012

  • The current yield is less than 6%
  • The current yield is 6%
  • The yield-to-maturity is greater than 6%
  • The yield-to-maturity is 6%
• Measures most similar to current yield on a bond

  • Discount rate on a Treasury Bill
  • Effective annual rate on a certificate of deposit
  • Dividend yield on a stock
  • Internal rate of return if the bond is held to maturity
• Bond immunization


  • Achieved when the offsetting reactions equally offset each other
  • Allows an investor to earn a specified rate of return on a bond portfolio regardless of what happens to market interest rates over the course of the holding period
• Active bond trading strategies

  • Trading on forecasted interest rate behavior
  • Bond swaps
• Reasons for using a bond ladder strategy

  • Uncertainty concerning future interest rates
  • Reducing the amount of time spent managing the bond portfolio
• Building a bond ladder

  1. Purchasing roughly equal amounts of bonds with staggered maturities ranging from short-term to some long-term investment horizon

  2. As the short-term bonds mature, they are replaced with long term bonds

  3. Protects the investor from changes in long-term interest rates while enjoying the typically higher yields on long-term bonds

  4. A form of dollar cost averaging
• Actual return on a bond is dependant on

  Coupon rate

  reinvested interest rate

  change in market price
• Ytm approach fails to consider

  Reinvestment risk

  price or market risk
• Stock quotes on most Internet service providers such as Yahoo Finance include

  I. the highest and lowest price over the last 52 weeks.

  Il. the closing price for the previous trading day.

  III. the opening price for the day.
• Lyon have

  • Convertibility at a fixed conversionratio
  • Put feature that gurantees the right to redeem the bond at prespecified price
• When the convertible bonds are first issued,

  • conversion price is higher than market price
  • Coupon rate is higher than if bond were not convertible
• Which of the following risks are included in the risk premium?

  II. liquidity risk

  III. financial risk
• Which of the following theories is consistent with yield curves sloping upward most of the time?

  I. market segmentation theory.

  III. liquidity preference theory.
• Which of the following risks can be essentially eliminated by immunizing a bond portfolio?

  Il. price risk

  III. reinvestment risk
• Which of the following statements concerning duration are correct?

  I. Duration is a weighted-average life of a bond.

  II. The Macaulay duration considers the timing of a bond's cash flows.

  III. The Macaulay duration uses the YTM of a bond to discount the cash flows.

  IV. For coupon bonds, duration will be less than the actual time to maturity.