Course outline
Module 1
Module 1: What a Bond Is
What a Bond Is
Knowledge check
Q1. What is a bond in the simplest terms?
- A. A share of ownership in a company
- B. A loan made by an investor to a borrower such as a government or corporation ✓
- C. A savings account offered by a bank
- D. A type of insurance policy against market losses
Why: A bond is a debt instrument: the investor lends money to the issuer (government, municipality, or corporation), which promises to repay the principal and pay periodic interest. Owning a share of a company describes stock, not a bond.
Q2. What is the face value (par value) of a bond?
- A. The current market price of the bond
- B. The interest rate the bond pays
- C. The amount the issuer promises to repay the bondholder at maturity ✓
- D. The total interest paid over the bond's life
Why: Face value, also called par value, is the principal amount the issuer agrees to repay when the bond matures. A typical bond has a face value of $1,000, though its market price can trade above or below that.
Q3. What is the coupon on a bond?
- A. The date the bond expires
- B. The fee charged to buy the bond
- C. The periodic interest payment the bondholder receives, usually expressed as a percentage of face value ✓
- D. The credit rating assigned by an agency
Why: The coupon is the fixed interest payment the issuer makes to bondholders, typically semiannually. A bond with a $1,000 face value and a 5% coupon pays $50 per year.
Q4. What does maturity mean for a bond?
- A. The date on which the bond is issued
- B. The date on which the issuer repays the face value and the bond's obligations end ✓
- C. The point at which the bond's price is highest
- D. The number of times the coupon is paid per year
Why: Maturity is the date when the principal is due back to the investor and the bond ceases to exist. Bonds are often classified as short-term, intermediate, or long-term based on time to maturity.
Q5. Why are bonds generally considered less risky than stocks?
- A. Bond prices never fluctuate
- B. Bondholders have a legal claim to interest and principal payments and are paid before stockholders in bankruptcy ✓
- C. Bonds are guaranteed by the stock market
- D. Bonds always pay higher returns than stocks
Why: Bondholders are creditors with contractual rights to scheduled payments and higher priority in liquidation. Bonds still carry risks, such as default and interest rate changes, and their prices can fluctuate, so they are not risk-free.
Module 2
Module 2: Issuers and Why They Borrow
Issuers and Why They Borrow
Knowledge check
Q1. What is a bond issuer?
- A. The investor who buys a bond
- B. The entity that borrows money by selling bonds ✓
- C. The credit rating agency that grades bonds
- D. The broker who executes bond trades
Why: A bond issuer is the entity, such as a government, municipality, or corporation, that sells bonds to raise money and promises to repay the borrowed amount with interest.
Q2. Which of the following is a common reason a government issues bonds?
- A. To pay for public infrastructure such as roads and schools ✓
- B. To earn profits from stock market trading
- C. To eliminate all of its existing debt
- D. To replace its currency with a new one
Why: Governments often borrow through bonds to fund large public projects like infrastructure, which would be costly to pay for entirely from current tax revenue.
Q3. Why might a corporation issue bonds instead of taking a bank loan?
- A. Bonds never require interest payments
- B. Bonds can allow the company to borrow larger amounts from many investors at once ✓
- C. Bonds give the company ownership control over its lenders
- D. Bonds are only available to companies with no existing debt
Why: Bonds let issuers raise large sums by selling debt to many investors in the public market, rather than relying on a single lender such as a bank.
Q4. What does a bond issuer promise to bondholders?
- A. A share of the company's ownership
- B. Repayment of the principal and periodic interest payments ✓
- C. Guaranteed profits from the issuer's operations
- D. Voting rights in company decisions
Why: When you buy a bond, the issuer agrees to pay you regular interest, called coupon payments, and to return the face value (principal) on the maturity date.
Q5. Why might a municipality issue a bond?
- A. To fund a local project such as building a new public library ✓
- B. To buy shares in private companies
- C. To avoid paying any taxes to the state
- D. To increase the value of its currency
Why: Municipalities commonly issue bonds, often called municipal bonds, to finance public projects like libraries, bridges, and water systems.
Module 3
Module 3: Face Value, Coupons, and Maturity
Face Value, Coupons, and Maturity
Knowledge check
Q1. What is a bond's face value (also called par value)?
- A. The current market price of the bond
- B. The amount the issuer promises to repay the bondholder at maturity ✓
- C. The total interest paid over the bond's life
- D. The yield the bond earns each year
Why: Face value is the principal amount the issuer agrees to pay back to the bondholder when the bond matures. It is fixed at issuance and does not change, even though the bond's market price may fluctuate.
Q2. A bond with a $1,000 face value and a 5% annual coupon rate pays how much in interest each year?
- A. $5
- B. $50 ✓
- C. $500
- D. $1,050
Why: The coupon payment is calculated by multiplying the face value by the coupon rate: $1,000 × 5% = $50 per year. This is the fixed interest the bondholder receives.
Q3. What is the coupon rate of a bond?
- A. The price at which the bond was originally sold
- B. The date on which the bond is repaid
- C. The annual interest rate paid as a percentage of face value ✓
- D. The total return including price changes
Why: The coupon rate is the stated annual interest rate, expressed as a percentage of the bond's face value. It determines the periodic interest payments the bondholder receives.
Q4. What does 'maturity' mean for a bond?
- A. The date the bond was first issued
- B. The date the issuer must repay the face value to the bondholder ✓
- C. The point when the bond starts paying coupons
- D. The moment the bond's price reaches its highest value
Why: Maturity is the date when the bond's life ends and the issuer repays the principal (face value) to the bondholder. Coupon payments typically stop at this point.
Q5. A bond has a 10-year maturity, a $1,000 face value, and a 4% coupon paid annually. Over its full life, how much total coupon income does an investor receive?
- A. $40
- B. $400 ✓
- C. $1,000
- D. $1,400
Why: The annual coupon is $1,000 × 4% = $40. Over 10 years, that totals $40 × 10 = $400. The $1,000 face value is returned separately at maturity and is not part of the coupon income.
Module 4
Module 4: Bond Prices and Yields
Bond Prices and Yields
Knowledge check
Q1. What happens to a bond's price when market interest rates rise?
- A. The bond's price rises to match the new rate
- B. The bond's price falls ✓
- C. The bond's price stays the same because coupon payments are fixed
- D. The bond's price becomes equal to its face value
Why: Bond prices and interest rates move in opposite directions. When market rates rise, newly issued bonds offer higher coupons, so existing bonds with lower fixed coupons become less attractive and their prices fall until their yield matches the market rate.
Q2. What is the coupon rate of a bond?
- A. The price the bond sells for in the market
- B. The annual interest payment as a percentage of the bond's face value ✓
- C. The yield an investor earns if the bond is held to maturity
- D. The rate at which the bond can be converted into stock
Why: The coupon rate is the fixed annual interest paid by the bond, expressed as a percentage of its face (par) value. For example, a $1,000 bond with a 5% coupon pays $50 per year.
Q3. A bond is trading at a price below its face value. What is this called?
- A. A premium bond
- B. A par bond
- C. A discount bond ✓
- D. A zero-coupon bond
Why: A bond trading below its face value is called a discount bond. This typically happens when its coupon rate is lower than current market interest rates, so buyers are paid back the difference through a lower purchase price.
Q4. Which measure of return considers both the bond's coupon payments and the gain or loss from buying at a price different from face value, assuming the bond is held to maturity?
- A. Current yield
- B. Coupon rate
- C. Yield to maturity ✓
- D. Par value
Why: Yield to maturity (YTM) is the total annualized return an investor earns if the bond is held until it matures, including all coupon payments and any capital gain or loss from the difference between purchase price and face value.
Q5. A $1,000 bond with a 6% annual coupon is priced at $1,000. What is its current yield?
- A. 3%
- B. 6% ✓
- C. 12%
- D. 60%
Why: When a bond trades at par (face value), its current yield equals its coupon rate. Current yield is annual coupon payment divided by price: $60 / $1,000 = 6%.
Module 5
Module 5: Interest Rates and Bond Prices
Interest Rates and Bond Prices
Knowledge check
Q1. What happens to the price of an existing bond when market interest rates rise?
- A. The bond price rises to match the new rate
- B. The bond price falls ✓
- C. The bond price stays exactly the same
- D. The bond price doubles
Why: When market interest rates rise, newly issued bonds offer higher coupon payments. Existing bonds with lower fixed coupons become less attractive, so their prices fall until their yield matches the current market rate.
Q2. What is the relationship between bond prices and interest rates?
- A. They move in the same direction
- B. They have no relationship
- C. They move in opposite directions ✓
- D. Bond prices are unaffected by interest rates
Why: Bond prices and interest rates have an inverse relationship. As interest rates go up, bond prices go down, and as interest rates fall, bond prices rise.
Q3. A bond with a face value of $1,000 pays a fixed annual coupon of $50. If market interest rates rise to 7%, what will happen to this bond's price?
- A. It will trade above $1,000 because its coupon is attractive
- B. It will trade below $1,000 because its 5% coupon is less than the market rate ✓
- C. It will trade at exactly $1,000 regardless of market rates
- D. It will be redeemed early by the issuer at face value
Why: The bond pays 5% ($50/$1,000), which is below the new market rate of 7%. Investors would only buy it at a discount to face value so that their effective yield rises to 7%, so the price falls below $1,000.
Q4. Which type of bond is generally MOST sensitive to changes in interest rates?
- A. A short-term bond maturing in 1 year
- B. A long-term bond maturing in 30 years ✓
- C. A bond with a very high coupon rate
- D. A bond issued by the government with a floating rate
Why: Long-term bonds have greater interest rate sensitivity because their fixed payments extend over many years, so changes in market rates affect their present value more significantly than short-term bonds.
Q5. If a bond's price rises above its face value, what is it called?
- A. A discount bond
- B. A zero-coupon bond
- C. A premium bond ✓
- D. A callable bond
Why: A bond trading above its face (par) value is called a premium bond. This typically happens when its coupon rate is higher than current market interest rates, making it more attractive to investors.
Module 6
Module 6: Credit Risk and Ratings
Credit Risk and Ratings
Knowledge check
Q1. What is credit risk in the context of a bond?
- A. The risk that interest rates will rise and reduce the bond's market price
- B. The risk that the bond issuer will fail to make required interest or principal payments ✓
- C. The risk that inflation will erode the purchasing power of the bond's payments
- D. The risk that the bond cannot be sold quickly without a significant price discount
Why: Credit risk, also called default risk, is the possibility that the issuer cannot meet its obligations to pay interest or repay principal on time.
Q2. Which credit rating agency is among the three major agencies that assign ratings to bonds?
- A. Federal Reserve Bank
- B. International Monetary Fund
- C. Moody's Investors Service ✓
- D. New York Stock Exchange
Why: Moody's, S&P Global Ratings, and Fitch Ratings are the three major credit rating agencies that evaluate the creditworthiness of bond issuers.
Q3. A bond rated BBB- by S&P is considered what type of investment?
- A. Investment grade, the lowest rating within that category ✓
- B. High yield, also called junk bond status
- C. Risk-free, since it is rated above default
- D. Defaulted, because it is below AAA
Why: BBB- is the lowest rating still considered investment grade by S&P. Ratings below BB+ are classified as speculative or high yield.
Q4. Generally, what happens to a bond's yield as its credit rating declines?
- A. The yield falls because riskier bonds are more stable
- B. The yield rises to compensate investors for taking on greater default risk ✓
- C. The yield stays the same because coupon payments are fixed
- D. The yield becomes zero once the rating drops below investment grade
Why: Investors demand higher yields for bonds with higher default risk. This extra yield over a comparable risk-free bond is called the credit spread.
Q5. Which of the following is an example of a credit rating downgrade?
- A. A bond's rating changing from AA to A ✓
- B. A bond's coupon rate increasing from 4% to 5%
- C. A bond's maturity being shortened from 10 years to 5 years
- D. A bond's face value rising from $1,000 to $1,100
Why: A downgrade means the rating moves to a lower grade, signaling higher perceived credit risk. Moving from AA to A is a downgrade, while the other options describe unrelated changes.
Module 7
Module 7: Buying, Selling, and Holding Bonds
Buying, Selling, and Holding Bonds
Knowledge check
Q1. When you buy a bond on the secondary market, from whom are you typically buying it?
- A. Directly from the issuing government or corporation
- B. From another investor who already owns the bond ✓
- C. From the Federal Reserve only
- D. From the bond's original underwriter at face value
Why: The secondary market is where previously issued bonds trade between investors. Buying directly from the issuer happens in the primary market at issuance, so after issuance you are buying from another holder.
Q2. A bond with a face value of $1,000 is trading at $950. What is this bond trading at?
- A. At a premium
- B. At par
- C. At a discount ✓
- D. At a yield of zero
Why: When a bond's market price is below its face value, it is trading at a discount. Buyers pay less than the $1,000 they will receive at maturity, which generates extra return.
Q3. If market interest rates rise after you buy a bond, what generally happens to the bond's market price?
- A. It rises, because the bond pays more interest
- B. It falls, because newer bonds offer higher yields ✓
- C. It stays the same, since face value is fixed
- D. It becomes free of interest rate risk
Why: Bond prices move inversely to interest rates. When new bonds pay higher rates, existing bonds with lower fixed coupons become less attractive, so their prices drop to bring their yields in line.
Q4. What is the difference between holding a bond to maturity and selling it before maturity?
- A. Holding to maturity guarantees you receive the face value and scheduled interest, while selling early exposes you to the bond's market price at the time of sale
- B. Selling early guarantees a higher return than holding to maturity
- C. Holding to maturity means you receive no interest payments
- D. There is no difference because all bonds are priced at face value
Q5. Which of the following is a common cost to consider when buying or selling individual bonds?
- A. A monthly maintenance fee paid to the bond issuer
- B. A bid-ask spread or broker commission ✓
- C. A tax paid directly to the Treasury on every purchase
- D. A penalty for holding the bond longer than one year
Why: Transaction costs when trading bonds include the spread between the bid and ask prices and any commission charged by a broker. These reduce your net return and should be factored into decisions.