FIN 6100 CORRECT A ANSWERS AND QUESTIONS
SET A+
✔✔What are 3 bond options that benefit the buyer/bondholder? - ✔✔1. Convertibility:
allow you to switch the bond for stock
2. floating rate: the coupon % will change with inflation and the market
3. Collateralization: gives you priority in case of default
✔✔What is an option that benefits the bond issuer? - ✔✔Call Options.
Means the issuer can buy back a bond for a small fee (typically the annual coupon
payment).
This is never beneficial to the buyer. Which means they are harder to sell.
✔✔What is risk? (in terms of this chapter) - ✔✔Uncertainty in future cash flow
✔✔The Interest Rate can be broken into two parts. What are they?
K (total return) = ? + ? - ✔✔1. Risk Free: minimum amount you'd have to pay someone
before they would invest.
This is always the same.
2. Risk Premium: How much extra you have to compensate for the risk of the
investment.
This changes depending on the asset.
K (total return) = K (risk free) + K (risk premium)
✔✔What are the 2 parts of the risk free rate?
k (total return) = K (risk free) + K (risk premium) - ✔✔1. the Real rate: base amount
, 2. Inflation Rate: amount to match inflation
✔✔What are the 3 parts that make up the risk premium?
k (total return) = K (risk free) + K (risk premium) - ✔✔1. default premium: probability that
the issuer won't pay on time.
2. Interest rate/time premium: compensates for risky long-term assets. (Shorter are
safer, less chance for default)
3. Liquidity premium: how easy it is to trade.
✔✔How is default risk measured? - ✔✔Through rated bonds.
AAA through C
(low risk to high risk)
✔✔In what 3 ways can firms lower their risk rating? - ✔✔1. Allow auditing (reduce info
asymmetry)
2. place restrictions on their debt (stay within debt bounds)
3. Pledge collateral
✔✔How can a company make their bond more liquid? - ✔✔Make them as standard as
possible. Any unique features make it more difficult to sell.
✔✔What are different names for "K" or interest rate? (6) - ✔✔- Discount rate
- interest rate
- yield to maturity
- competitive rate
- cost of capital
- required return
✔✔What are the 3 ways to estimate a firm's cost of debt from most desirable to least? -
✔✔1. Find a competitive yield from bonds
2. use current interest expense relative to existing debt
3. build your own by comparing to similar bonds
✔✔What are the 3 types of yield and when should they be used? - ✔✔1. yield to
maturity: when it is a similar length
2. current yield: short-term project
SET A+
✔✔What are 3 bond options that benefit the buyer/bondholder? - ✔✔1. Convertibility:
allow you to switch the bond for stock
2. floating rate: the coupon % will change with inflation and the market
3. Collateralization: gives you priority in case of default
✔✔What is an option that benefits the bond issuer? - ✔✔Call Options.
Means the issuer can buy back a bond for a small fee (typically the annual coupon
payment).
This is never beneficial to the buyer. Which means they are harder to sell.
✔✔What is risk? (in terms of this chapter) - ✔✔Uncertainty in future cash flow
✔✔The Interest Rate can be broken into two parts. What are they?
K (total return) = ? + ? - ✔✔1. Risk Free: minimum amount you'd have to pay someone
before they would invest.
This is always the same.
2. Risk Premium: How much extra you have to compensate for the risk of the
investment.
This changes depending on the asset.
K (total return) = K (risk free) + K (risk premium)
✔✔What are the 2 parts of the risk free rate?
k (total return) = K (risk free) + K (risk premium) - ✔✔1. the Real rate: base amount
, 2. Inflation Rate: amount to match inflation
✔✔What are the 3 parts that make up the risk premium?
k (total return) = K (risk free) + K (risk premium) - ✔✔1. default premium: probability that
the issuer won't pay on time.
2. Interest rate/time premium: compensates for risky long-term assets. (Shorter are
safer, less chance for default)
3. Liquidity premium: how easy it is to trade.
✔✔How is default risk measured? - ✔✔Through rated bonds.
AAA through C
(low risk to high risk)
✔✔In what 3 ways can firms lower their risk rating? - ✔✔1. Allow auditing (reduce info
asymmetry)
2. place restrictions on their debt (stay within debt bounds)
3. Pledge collateral
✔✔How can a company make their bond more liquid? - ✔✔Make them as standard as
possible. Any unique features make it more difficult to sell.
✔✔What are different names for "K" or interest rate? (6) - ✔✔- Discount rate
- interest rate
- yield to maturity
- competitive rate
- cost of capital
- required return
✔✔What are the 3 ways to estimate a firm's cost of debt from most desirable to least? -
✔✔1. Find a competitive yield from bonds
2. use current interest expense relative to existing debt
3. build your own by comparing to similar bonds
✔✔What are the 3 types of yield and when should they be used? - ✔✔1. yield to
maturity: when it is a similar length
2. current yield: short-term project
