Cfa Level 1 - 2012 - Fixed Income

Front 1

Sovereign Debt:

Back 1

Bonds issued by central government.

The US Treasury securities are considered free of default risk.

Considered risk free.

Front 2

Regular Cycle Auction - Single price:

Back 2

The highest price at which the entire issue can be sold.

Front 3

Regular Cycle Auction - Multiple Bid:

Back 3

Winner bidders receive the bonds at whatever price they bid.

Front 4

Ad Hoc System:

Back 4

Government auctions new securities when the market conditions are advantageous.

Front 5

Tap System:

Back 5

Bonds are identical to previously issued bonds.

They release them whenever they need them.

Front 6

T-Bills:

Back 6

Treasury Bills. Pure discount securities, 0-coupon bonds.

Simply buy them for a certain price, then mature at another.

Front 7

Notes and Bonds:

Back 7

Offer semi-annual coupon payments.

Front 8

TIPS:

Back 8

Treasury Inflation Protected Security:

- Coupon rate is fixed
- Real rate of return
- Par value is adjusted for inflation.

1/2 coupon rate x inflated adjusted par value = Semi-annual payments.

Like a floating coupon rate except the PV is adjusted.

Front 9

On-the-Run Issues:

Back 9

The most recently issued security.
Have the most accurate pricing and are the most liquid.

Front 10

Off-The-Run-Issues:

Back 10

Older issued security.

Front 11

Stripped Treasury Security:

Back 11

0 coupon bond created from treasury notes and bonds; the pieces are separated.

Coupon strips are denoted CI
Principle stripes are denoted PI

Strips are taxed on explicit interest.

Front 12

Securities Issued by Federal Agencies:

Back 12

Federal related institutions:
GNMA, TVA...

Front 13

Government Sponsored Enterprises:

Back 13

Salie Mae, Freddie Mac, Mannie Mae

Front 14

Agency Securities:

Back 14

Very little risk.

Front 15

Debentures:

Back 15

Securities not backed by collateral; unsecured bonds.

Front 16

MPS:

Back 16

Mortgage Pass-through Security is a security made from a pool of mortgages.
The owner of a such a security gets a certain percentage of the interest, principle, and prepaid principle in return for purchasing the security.

The risk with these securities is that when interest rates go up, prepayment of principle goes down since no one wants to refinance a mortgage when interest rates are going up.

Front 17

CMO:

Back 17

Collateralized Mortgage Obligations:

Created from MPS with the main goal being to level out the risk from the pre-payment drops due to interest rate rises.

There are three Tranches; short, medium, and long period and get filled up in that order.

Basically when payments start coming in from prepayments due to low interest rate risk they are redirected towards these tranches that then pay out a coupon payment to make the MPS attractive again.

Front 18

Prepayment Risk:

Back 18

When interest rates fall prepayments start coming in and this causes the lender to reinvest that money at a low interest rate.

Front 19

Municipal Securities:

Back 19

Exempt from income tax in the state of issue.

Front 20

Tax backed Bonds:

Back 20

General Obligation Bond, depend on the taxing authority for payments.

Front 21

Revenue Bonds:

Back 21

Depends on the revenue generated from a specific government project, like a toll road.

Front 22

Insured Bonds:

Back 22

Backed by insurance policies in the event of defaults.

Front 23

Secured Debt:

Back 23

Like a mortgage bond; it is asset backed.

Front 24

Debenture Bond:

Back 24

Unsecured bond.

Front 25

Revenue Bonds:

Back 25

Depends on the revenue generated from a specific government project, like a toll road.

Front 26

Insured Bonds:

Back 26

Backed by insurance policies in the event of defaults.

Front 27

Pre-refunded bond.:

Back 27

Bonds that have their principle cash amount already held aside by the original issuer of the debt. A subset of the municipal and corporate bond classes, the funds required to pay off refunded bonds are held in escrow until the maturity date, usually by purchasing Treasury or agency paper.

Refunded bonds will typically be 'AAA' rated due to the cash backing and, as such, will offer little premium to equivalent-term Treasuries. The date of refunding will usually be the first callable date of the bonds.

Front 28

Secured Debt:

Back 28

Like a mortgage bond; it is asset backed.

Front 29

Debenture Bond:

Back 29

Unsecured bond.

Front 30

Senior Debenture:

Back 30

Bonds have a priority of repayment, seniors have the highest one.

Front 31

Commercial Paper

Back 31

2-270 days, not liquid, basically corporate IOU.

Front 32

Medium Term Note:

Back 32

Continuously offered by an agent.
They can be created anytime and are very customizable.

Front 33

Structured Security:

Back 33

Medium Term Note combined with some debenture.

Front 34

Negotiable CB

Back 34

Days to Years,
Secondary market.

Front 35

Bankers Acceptance:

Back 35

Created to guarantee payment for shipped goods.

Short term,
Pure discount,
Liquidity risk.

Front 36

ABS:

Back 36

Asset Backed Security:
Backed by financial asset like receivables.

Sold by creating a SPV: Special Purpose Vehicle which a security formed from AR.

Front 37

External Credit Enhancement:

Back 37

Certain ABS have a high default rate and therefore are unattractive to investors. To make the ABS more attractive, a external credit enhancement is applied. It basically is a guarantee of payment via insurance.

Front 38

CDO:

Back 38

Collateralized Debt Obligation:
A security that can be created basically out of anything.

Front 39

Primary Market:

Back 39

Newly created securities:
- Firm commitment: the banker purchases a whole issue and resells it.
- Best effort basis: Banker attempts to sell as much as he can.
- Private Placement: The issues are sold privately.

Front 40

Interest Rate Policy Tools:

Back 40

Open Market Operations,
Discount Rate,
Bank Reserve Requirements.

Front 41

Open Market Operations:

Back 41

Buying and selling treasury securities in the open market.

Front 42

Discount Rate:

Back 42

the rate that the bank borrow from the fed in order to keep up their reserves.

Front 43

Bank Reserve Requirements:

Back 43

The amount of money a bank has to keep in reserve.
If they change it this has an effect on lending rates since a lower bank reserve will free up money for the banks.

By buying bonds in the open market they put out new cash in to the system because before that money was sitting in the treasury inaccessible to nongovernmental people.

Front 44

Term Structure Theory:

Back 44

1) Pure expectation theory
2) Liquidity preference Theory
3) Market Segmentation Theory

Front 45

Pure expectation theory:

Back 45

This theory signifies that a Yield graph is an indication of the markets expectations. For instance, an increase in yield in regards to maturity signifies an expectation of interest rate rise.

A flat expects interest rate to stay flat.

A decline expects interest rate falls.

Front 46

Liquidity preference Theory:

Back 46

Similar to purse expectation theory.
Since longer maturity = more risk.

Front 47

Market Segmentation Theory:

Back 47

There are segmentation to the yield curve in regards to short, medium, and long term durations. Some companies work in the short term while others in the long term.

There is a supply and demand in each segment and a curve can be any shape.

Front 48

Treasury Spot Rates:

Back 48

the appropriate discount rate at a point in the future.

Front 49

Absolute Spread:

Back 49

Absolute Spread = High yield - low yield

Front 50

Relative Spread:

Back 50

Yield on subject bond / yield on benchmark bond

Front 51

Yield Ratio:

Back 51

Exactly the same as relative spread except no -1

Front 52

Credit Spread:

Back 52

Difference between yields of bonds that only differ in credit rating.

Often known as a spread to treasuries.

Credit spreads narrow during growth and widen during recession.

Front 53

Call option

Back 53

Call away from the bond holder.
Therefore it increases yield in order to keep the bond attractive.

Front 54

Less Liquid =

Back 54

More yield & great yield spread

Front 55

After Tax Yield =

Back 55

Taxable Yield(1-Tax)

Y = 7%
Tax = 30%
= 0.07(1-0.3)

Front 56

Taxable Equivalent Yield =

Back 56

Takes the tax free yield backwards in regards to the after tax yield formula:
Tax free Yield / (1-tax)

Front 57

LIBOR:

Back 57

London Interbank Offer Rate:
Most important reference rate for floating-rate securities.

Front 58

Funded Investor:

Back 58

Borrowing short-term at LIBOR to finance an investment.

Front 59

Arbitrage Free Bond Pricing:

Back 59

The yield curve represents a change in yield throughout time. By using a spot rate it is possible to discount SINGLE future coupon payments using a spot rate.

So for a whole bond since there is a bunch of coupon payments you discount each coupon payments at different spot rates.

There is arbitrage in this since the spot rate can be higher than the yield.

Front 60

PV =

Back 60

FV / [(YTM/2)+1]

Front 61

How to profit of arbitrage in regards to bonds?

Back 61

If the arbitrate free value is higher then but the bond, strip and sell the coupons.

If the arbitrage free value is less than the bond value then buy the stripped coupons and make a bond.

Front 62

YTM is also known as...

Back 62

BEY: Bond Equivalent Yield

REMEMBER ON THE EXAM THEY WILL TRICK YOU, ALWAYS MAKE IT SEMI-ANNUAL YIELD BECAUSE ITS A BOND!!!

so if it's annual on your calc, transfer it back to semi-annual!!!

Front 63

Current Yield =

Back 63

Annual Coupon Payment / Current Price