Chartered Financial Analyst (CFA) Practice Exam Level 2

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What does the formula P = SUM[(Coupon) / (1 + SPOTRT)^T] + (Principal) / (1 + SPOTRT)^T calculate?

Yield to Maturity of a Bond
Price of a Bond
Current Yield of a Bond
Future Value of a Bond

The correct answer is: Price of a Bond

The formula P = SUM[(Coupon) / (1 + SPOTRT)^T] + (Principal) / (1 + SPOTRT)^T is used to calculate the price of a bond. It represents the present value of future cash flows, which consist of the periodic coupon payments and the principal amount that will be repaid at maturity. In this context, each coupon payment is discounted back to the present value using the relevant spot rates (SPOTRT), and the principal is also discounted using the same methodology. This approach ensures that all cash flows are appropriately valued as of the current point in time, reflecting the time value of money. The sum of these present values gives the total price investors are willing to pay for the bond today. The other choices relate to different concepts in bond valuation and investment analysis. For example, yield to maturity focuses on the bond's annual return if held to maturity, while current yield measures the income (from coupons) relative to the price but does not account for the time value of the principal or future cash flows. Future value, on the other hand, pertains to how much an investment will grow over time, not the current price of an asset.