Lesson 7.3 - Bond Investing

Which of these bond terms is most similar to the stock market concept of interest rate?

• default risk

• speculating

• par value

• coupon

Which of these statements does NOT accurately describe Treasury bonds?

• They are the least risky bond investment you can make

• Investors are drawn to them because they typically pay a high coupon.

• You can purchase them without using a broker at all.

• They are available in smaller denominations than corporate bonds.

Interest rates and bond prices inversely related, which means that when interest rates, rise, bond prices will fall.

• True

• False

Which of the following is NOT an advantage of purchasing a bond fund instead of an individual bond?

• You get to choose all of the individual bonds you want to put into your fund.

• Your risk is diversified over multiple bonds, so if one does poorly, your entire fund isn’t ruined

• Bond funds are more cost effective because they don't require the constant buying and selling of individual bonds

• A bond professional has chosen the makeup of the funds, so you benefit from their knowledge.

Which of the following statements about stocks and bonds are TRUE?

• Stocks are generally considered less risky investments than bonds

• If a company goes bankrupt, bondholders come before stockholders in determining how the remaining assets of the company are divided

• Most individuals create portfolios consisting of all stocks or all bonds but rarely ever combine the two asset types

• Stock prices and bond prices change on a daily basis

• The annual income that comes from an investment in stock of a company is called a dividend while the annual income from a bond is called a coupon

Which of these 10-year bonds is considered the safest investment?

• U.S. Treasury Bonds

• Non-investment grade Corporate Bond (Junk bonds)

• AAA-rated Corporate Bond

• A-rated Corporate Bond

What is the relationship between the credit quality of a bond and its coupon rate?

• There is no relationship between credit quality and the bond’s coupon rate

• The higher the credit quality of a bond, the lower the coupon rate, all other things being equal

• The lower the credit quality of a bond, the lower the coupon rate, all other things being equal

• The higher the credit quality of a bond, the higher the coupon rate, all other things being equal

You are comparing two bond mutual funds: Bond Fund A is made up of U.S. Treasury bonds and has earned 4% per year on average over the past five years. Bond Fund B is made up of “junk bonds” of U.S. corporations and has earned 9% per year on average over the past five years. Which of the statements below is TRUE?

• Bond Fund B is clearly the better choice since it has had a higher overall return over the past five years

• Bond fund A would likely perform worse in a difficult economy since it has bonds of lower credit quality

• Bond Fund B has had a better return since it’s non-investment grade bonds are riskier than Bond Fund A and investors expect higher returns from higher risk investments

• Given Bond Fund B’s higher risk, you should expect that it will always have higher returns than Bond Fund A.

Jamie invests $1,000 in a 5% coupon bond issued by Nike that has a term of 10 years. Which of the following statements about this bond are TRUE?

• If the bond is held for the full term. Jamie would have received $500 in coupon payments ($50/year) plus a $1,000 principal payment at the end of the term

• IF the bond was sold before the end of the ten year term, she would be guaranteed to receive the $1,000 principal back plus any coupon payments

• It is likely that the coupon rate would be adjusted several times during the bond term

• If interest rates dropped significantly in the first year that Jamie held the bond, the price of the bond would likely be higher than on the date she bought it.

Samantha sees information about a bond index fund with the following characteristics:

Average coupon rate of 2.5%.

She plans to invest $1,000 which meets the minimum requirements.

Average credit quality of AA.

Primarily invests in U.S. Treasury Bonds.

Average duration (fancy word for term) of 4.5 years.

Expense ratio of .15% (average expense ratio for funds like this is 1.0%).

Based on the characteristics, which of the following are TRUE?

• She should receive about $25 a year in income from this fund

• This appears to be quite a risky investment for Samantha

• Having a low expense ratio usually means that the fund is not as well managed as a fund with a high expense ratio

• Since this is a low-risk investment, there is no chance that her investment would drop under $1,000

• Since this is an index fund, the fund seeks to buy the bonds in a standard bond index and is not trying to "beat the bond market."