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54 Cards in this Set
- Front
- Back
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What are the primary risks that bonds are subject to
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DRIP
Default Reinvestment Interest Rate Purchasing Power |
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Explain the three yield curves--normal(positive), flat and inverted
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Normal-curves up to right--predicts that market interest rates will rise in future\Flat yield curve when economy is peaking, therefore no change in interest rates
inverted--interest rates will fall in future--inflationary economy |
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What are the three predominant yield curve theories?
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Expectations theory, liquidity preference and market segmentation theory
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What is the expectations theory for yield curves.?
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States that long term rates consist of many short term rates and long term rates will be the average
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What is the liquidity preference theory for yield curves?
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Investors pay a premium for shorter (lower yields) for shorter maturity bonds. Liquidity theory is the only yield curve theory that does not explain a negative yield curve.
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What is the market segmentation theory for yield curves?
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Market for bonds divided into short, intermediate and long term markets
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What is the duration of a bond?
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The time it takes the bondholder to receive the interest and principal from a bond in present value dollars. The coupon rate of a bond and its duration have an inverse relationship. Same for YTM
The term and its duration have a direct relationship A zero coupon bond will always have a duration equal to its term to maturity |
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What is convexity?
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Measures the curvature of the relationship between a bond's ytm and its market price. explains degree to which duration changes as a result of changes in YTM. Measures the curvature of the price yield relationship It has the same relations to coupon rate, YTM and Term as duration. Convexity is greatest in low coupon bonds, LT bonds, low YTM
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A bond cost $974.22 with a Macaulay duration of 2.8, pays interest annually and its ytm changes from 8 to 7.5 (i.e., market interest rates go down), what is the estimated change in the price of the bond.
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It will increase by 1.3%
-2.8x (1.075-1.08) ---------------- 1.08 |
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Discuss the methodology used to immunize a bond portfolio from risk
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A bond portfolio is said to be immunized from interest rate and reinvestment rate risk when the duration of the portfolio is equal to the time horizon of the investor. For example, if the time horizon of the investor were 10 years, a simple way to protect against interest rate and reinvestment rate risk would be to fund the portfolio only with zero coupon bonds with a 10 year term.
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Why are there higher yields on long term bonds?
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Two reasons 1) investor expect a rise in interest rates; 2) the longer maturities entail a greater risk for the investor.
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How does a high duration affect bond value?
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The higher a bond’s duration, the greater its sensitivity to interest rates changes. This means fluctuations in price, whether positive or negative, will be more pronounced. If you sell before maturity, the price you receive will be affected by the prevailing interest rates and duration. For instance, if interest rates were to rise by two percent from today’s low levels, a medium investment grade corporate bond (BBB, Baa rated or similar) with a duration of 8.4 (10-year maturity, 3.5 percent coupon) could lose 15 percent of its market value. A similar investment grade bond with a duration of 14.5 (30-year maturity, 4.5 percent coupon) might experience a loss in value of 26 percent.1 The higher level of loss for the longer-term bond happens because its duration number is higher, making it react more dramatically to interest rate changes
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What risk are zero coupon bonds not subject to?
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reinvestment rate risk because they do not pay periodic interest
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What is the term of a treasury note?
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up to 10 years. minimum purchase is $100
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What is the term of a treasury bond
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up to $30 years . minimum purchase is $100
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What are TIPS
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Treasury Inflation Protected Securities. Issued for 5, 10 or 30 years in $100 multiples. The principal value of the bond is adjusted for changes in the CPI. Interest is fixed but paid on adjusted principal
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What is a STRIP
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Separately traded registered interest and principal securities. P & I are separated. Traded by financial institutions and government securities brokers.. Each strip=zero coupon components.
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What are I and E savings bonds
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If purchased by a 24+ year old can be used for education. $10K max purchase per year. Taxed at maturity. Issued at discount There is also an H bond that has been discontinued.
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What are GNMA (government agency), FNMA, FHLMC (government sponsored)
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mortgage backed securities. AGENCY SECURITIES HAVE SLIGHTLY HIGHER YIELDS THAN TREASURIES BECAUSE OF LOWER LIQUIDITY
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What are CMOs
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collateralized mortgage obligations created by private investment firms. Streams of principal and interest payments are distributed to different classes (tranches) Investors in first tranche receive all principal payments. No reinvestment risk.
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What are private activity bonds
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Bonds issued by municipalty to provide local industries with plant and equioment. more than 10% of proceeds are used for private business use (stadium)
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What are serial bonds
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issued by municipalities wherein specified series of bonds matuire each year until final maturity. series of maturity dates with a portion maturing each year.
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What is an indenture
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corporate secured bond--indenture--can be a mortgage bond, or collateral trust bond
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what is a debenture
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unsecured corporate bond
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What is a subordinated debenture
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junior to claims of other general creditors
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What is the rating of investment grade bonds?
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BBB or better. An upward revision will cause the market yield to decline.
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At what rating will the bond begin to be considered junk
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BB and below
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What is a convertible bond
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a hybrid security that allows holder to buy shares of cs. Convertible bonds allow issuer to reduce cost of intrest by paying lower yield
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What are the major adv and disadv of convertible bonds
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Holder can participate in the growth of the underlying company. Disadv. lower yield compared with yields of nonconvertible bonds.
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What is the bond investment premium for convertible bonds?
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Bond price less investment value. If the premium is greater than the conversion premium (mv of stock less conversion value) than the conversion value (conversion ratio x mv of share) is greater than the MV of stock
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What is the conversion ratio
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No of shares you can buy with the stock =parvalue/conversion price
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What is a yankee bond
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a foreign us dollar denominated bond issued by foreign governments or corporations. generally high quality and traded on otc and registered with sec
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What is a eurodollar bond
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issued and traded o/s us
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What is a guaranteed investment contract
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sold primarily by insurance companies to pensions.
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What is the current yield of a bond
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annual interest/cost
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What should be the bond strategy when interest rates are declining
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invest in bonds for price appreciation opportunity
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Which bonds will be most sensitive to interest rate risks when considering term and coupon rates.
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Bonds with low coupon rates and long maturities will be most sensitive to interest rate changes. and have higher price fluctuations than bonds of shorter maturities and longer coupon rates. Consequently the most volatile bond will be a long term zero coupon
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What are the three theories regarding yield curves
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Expectations theory-LT rates are many st rates
Liquidity preference theory=premium for LT market segmentation-supply and demand. market =st, intermediate 1-5, and longterm |
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Which is a better measure of risk, maturity or duration
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Duration. Duration provides a close approximation of change ( if 1 percent or less) in price of bond by change in interest rates
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What are the different types of bond swaps
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tax (gaining from capital loss), substitution (xchanging bonds with identical xteristics), yield (low yield to higher yield); intermarket (corporate to government, change categories) rate anticipation (long term to short term)
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What are the relationships of duration and convexity to term, yield and coupon rate
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Convexity and duration have the same relationship
direct, inverse and inverse respectively |
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What is modified duration and how can it be used as a shortcut to determine the to what extent a change in interest rates affects bond price
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Modified duration = D/1 + Y. This gives you the change in price for 100 basis points
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What is bond ladder
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Purchasing in STAGGERED maturities
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What is a barbell
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Equal weight on both sides Very long term and very short term maturities. requires active management
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Bullet strategy
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similar maturities focused around a point in time.
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What is the goal of immunization and when is a portfolio immunized
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The goal of immunization is to protect a bond portfolio from interest rate fluctuations and reinvestment rate risk. The portfolio is immunized if the realized rate of return is at least the computed YTM that was calculated at inception Also should match duration with time horizon for a financial goal
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What equity securities keep up with inflation
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TIPS and I bonds
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What are EE/E bonds
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gov bonds sold at face value. Interest NOT taxable until redeemed. Can trade if acquired b4 9/2004) EE to HH. Interest can be excluded from income if used for education
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What are HH bonds
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Pay semiannual interest (NOT ZERO)
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What are I bonds
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Accrue interest on inflation indexed. Earning rate =coupon plus semi annual inflation rate. Excluded from income if used for education
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What is the difference between general obligation muni bond and revenue bond
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GO backed by government issuer; revenue bond repaid by revenue. Private activity bond is for private business use of 10%r greater like a stadium but also a muni
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What are the factors that affect duration?
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NYC-New York City
No of periods or maturity Yield Coupon |
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What is the formula for determining how much you owe on a margin call
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VLER
Value of stock - LOAN = EQUITY - Required EQUITY = Amount you owe |
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What are some of the risks related to mortgage backed securities
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Prepayment risk, inflation and intrest rate risk.
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