test 2 study guide - Investment grade bonds those above Ba...

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Investment grade bonds: those above Ba or BB . Junk bonds or high yield bonds: with ratings below Baa or BBB . Given: $100 face value, 7% coupon rate, 20% tax rate, 1 year maturity. The yield is 5.6 %. 7% x(1-0.2) 20%=5.6 Yields on short-term bonds are more volatile than on long-term bonds. Long-term yields tend to be (but not always) greater than short-term yields. The long-term interest rate is the average of the _ current short term and expected short term interest rates. If investors expect the interest rate to decline, the long-term interest rate will be less than the short-term interest rate. The yield curve will slope downward . If investors expect the interest rate to rise, the long-term interest rate will be greater than the short-term interest rate. The yield curve will slope upward . If the current short-term rate is 6%, the short-term rate next year is 7%, and the short-term rate in year 3 is 8%, then the long-term rate is likely to be 7 % . If the risk-free yield is 4%, risk premium is 3%, then the bond yield is 7 % . A _ steep yield curve means a strong _ economy. A _ flat yield curve means a soft _ economy. A _ inverted _ yield curve means a _ recession is coming _. Stockholders are _ partial ownership of a firm _. Stockholders have limited _ liability. Loss cannot exceed the price they paid for the stock. D1=5, i=0.03, P1=80. Stock value = 4.85+77.67=85.82---5/(1.03)^1+80/(1.03)^1 D1=5, D2=8, i=0.04, P2=50. Stock value = 4.81+7.40+46.23=58.44 ---(5/1.04)^1+(8/1.04)^2+(50/1.04)^2 The fundamental (or present) value of a stock is: D=5, i=0.06, g=0.01, PV of the stock= 101---5x(1+0.01/0.06-0.01) D2=10, P1=90, P2=120. Return to hold stock = 0.1111+0.3333=0.4444----10/90+120-90/90 Prices of stocks and other financial instruments reflect all available information.
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