Unformatted text preview: than the prices
of short-term bonds, and vice versa.a Contractual provision risk Conditions that are often included in a debt agreement or a
stock issue. Some of these reduce risk, whereas others may
increase risk. For example, a provision allowing a bond issuer
to retire its bonds prior to their maturity under favorable
terms increases the bond’s risk. aA detailed discussion of the effects of interest rates on the price or value of bonds and other fixed-income
securities is presented later in this chapter. CHAPTER 6 Interest Rates and Bond Valuation 273 the highest risk premiums and therefore the highest returns result from securities
issued by firms with a high risk of default and from long-term maturities that
have unfavorable contractual provisions. Review Questions
6–3 6–4 6–5 LG2 LG3 What is the real rate of interest? Differentiate it from the nominal rate of
interest for the risk-free asset, a 3-month U.S. Treasury bill.
What is the term structure of interest rates, and how is it related to the
For a given class of similar-risk securities, what does each of the following
yield curves reflect about interest rates: (a) downward-sloping; (b) upwardsloping; and (c) flat? Which form has been historically dominant?
Briefly describe the following theories of the general shape of the yield
curve: (a) expectations theory; (b) liquidity preference theory; and (c) market segmentation theory.
List and briefly describe the potential issuer- and issue-related risk components that are embodied in the risk premium. Which are the purely debtspecific risks? 6.2 Corporate Bonds corporate bond
A long-term debt instrument
indicating that a corporation has
borrowed a certain amount of
money and promises to repay it in
the future under clearly defined
coupon interest rate
The percentage of a bond’s par
value that will be paid annually,
typically in two equal semiannual payments, as interest. A corporate bond is a long-term debt instrument indicating that a corporation
has borrowed a certain amount of money and promis...
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