Cfa Level 1 Fixed Income, Derivatives And Alternative Investments

Front 1

How to interpret that the price-yield relationship for bond is convex?

Back 1

The percentage decrease in value when the YTM increases by a given amount is smaller than the increase in value when the YTM decreases by the same amount.

Front 2

How to calculate the flat price?

Back 2

full price = flat price + accrued interest
- days past after the last payment should be accounted for

Front 3

What is clean price and what is dirty price?

Back 3

Dirty price: full price
Clean price: flat price

Front 4

What are the conventions used for government bond and corporate bond?

Back 4

Government bond: actual / actual
Corporate bond: 30 / 360

Front 5

What is the difference between street convention and true yield?

Back 5

street convention calculates the yield based on the stated coupon dates (they might not be actual coupon dates because they might fall on weekend)

Front 6

Current yield for a bond?

Back 6

annual cash coupon payment / bond price

Front 7

Simple yield for a bond?

Back 7

the sum of the annual coupon payment plus (minus) the straight-line amortization of a discount (premium) is divided by the flat price

Front 8

What is quoted margin and required margin?

Back 8

quoted margin is used to calculate the coupon payments for FRN
required margin is used to calculate the FRN par value

Front 9

What principle should be used to calculate spot rate from forward rates or vice versa ?

Back 9

No arbitrage principle

Front 10

on-the-run government bond?

Back 10

The most recently issued U.S. Treasury bond or note of a particular maturity. "On-the-run" Treasuries are the opposite of "off-the-run" Treasuries, which refer to Treasury securities that have been issued before the most recent issue and are still outstanding.

Front 11

What is a G-spread?

Back 11

A yield spread over a government bond is also known as a G-spread

Front 12

What is I-spreads?

Back 12

Yield spreads relative to swap rates are known as interpolated spreads

Front 13

What is Z-spread

Back 13

The constant spread that will make the price of a security equal to the present value of its cash flows when added to the yield at each point on the spot rate Treasury curve where a cash flow is received . In other words, each cash flow is discounted at the appropriate Treasury spot rate plus the Z-spread.

Front 14

What is OAS and what is its relationship with Z-spread?

Back 14

OAS stands for Option Adjusted Spread
option value = Z-spread - OAS

Front 15

What is Macaulay duration? what does it measure?

Back 15

weighted average of the number of years until each of the bond's promised cash flow.
Macaulay duration= CF_1 / CF_all * 1 + CF_2 / CF_all * 2 + .... + CF_n / CF_all * n
all CF here are present value
it measures a bond's interest rate risk or sensitivity of a bond's full price to a change in its yield

Front 16

What is Modified Duration?

Back 16

ModDur = Macaulay duration / (1 + YTM)
approximate percentage change in bond price = -ModDur * ΔYTM

Front 17

How to calculate ModDur quoted on a semiannual bond analysis?

Back 17

ModDur = MacDur / (1 + YTM/2)

Front 18

How to calculate approximate modified duration?

Back 18

Approximate modified duration = (V_ - V+) / (2 * V_0 * ΔYTM)

Front 19

Effective duration

Back 19

(V_ - V+) / (2 * V_0 * ΔCurve)
it measures the interest rate sensitivity

Front 20

how to calculate portfolio duration?

Back 20

portfolio duration = ΣW_i*D_i
W_i = full price of bond i divided by the total value of the portfolio
D_i = the duration of bond i

Front 21

What is money duration?

Back 21

money duration = annual modified duration * full price of bond position

or money duration = annual modified duration * full bond price per 100 of par value

Front 22

What is PVBP?

Back 22

PVBP stands for price value of a basis point
PVBP is the money change in the full price of a bond when its YTM changes by one basis point

PVBP = (V_ - V+) / 2

Front 23

approximate convexity

Back 23

(V_ + V+ - 2*V_0) / ((ΔYTM)^2 * V_0)

Front 24

approximate effective convexity

Back 24

(V_ + V+ - 2*V_0) / ((Δcurve)^2 * V_0)

Front 25

change in full bond price (factoring duration and convexity)

Back 25

-annual modified duration * ΔYTM + 1/2 * annual convexity * (ΔYTM)^2

Front 26

What is duration gap and how to interpret it?

Back 26

duration gap = Macaulay duration - investment horizon

a positive duration exposes investor to market price risk from increasing interest rates. a negative duration gap exposes the investor to reinvestment risk from decreasing interest rate

Front 27

Expected loss of bond default?

Back 27

default risk * loss security

Front 28

recovery rate?

Back 28

1 - loss severity

Front 29

What are the seniority rankings for debt payment?

Back 29

from senior to junior:
first lien or first mortgage (specific asset is pledged)
senior secured debt
junior secured debt
senior unsecured debt
senior subordinated debt
subordinated debt
junior subordinated debt

Front 30

What is pari passu?

Back 30

debt with the same seniority is said to rank pari passu

Front 31

What is CFR and what is CCR?

Back 31

CFR stands for Corporate Family Ratings (specific to the issuer of the bond)
CCR stands for Corporate Credit Ratings (applicable to the issue)

Front 32

What are the key components of credit analysis? (hint: 4 Cs)

Back 32

Capacity, Collateral, Covenants, Character

Front 33

What are the components of yield spread?

Back 33

yield spread = liquidity premium + credit spread

Front 34

How to calculate return impact caused by spread changes?

Back 34

small changes:
return impact ≈ - modified duration * ∆spread

large changes
return impact ≈ - modified duration * ∆spread + 1/2 * convexity * (∆spread)^2

caution: convexity should be corrected according to the scale of modified duration squared

Front 35

What is Mezzanine-stage financing?

Back 35

the capital provided to prepare the firm for an IPO

Front 36

How to calculate futures price?

Back 36

future price ≈ spot * (1 + risk-free rate) + storage costs - convenience yield

Front 37

Contango vs backwardation?

Back 37

Contango: there is little or no convenience yield, futures will be higher than spot prices
backwardation: the convenience yield is high, futures prices will be less than spot prices

Front 38

Hard hurdle rate vs soft hurdle rate?

Back 38

Hard hurdle rate:
incentive fees are earned only on returns in excess of the benchmark
Soft hurdle rate:
incentive fees are paid on all profits if the hurdle rate is met

Front 39

What is Eurodollar deposits?

Back 39

Deposits in large banks outside the United States denominated in U.S. Dollars

Front 40

What is FRA and what is a long position in FRA?

Back 40

FRA is Forward Rate Agreement
Long is the party which would borrow the money (long the loan with the contract price being the interest rate on the loan)

Front 41

What does 2-by-5 FRA mean?

Back 41

long position means loan the money at the specified rate 60 days from now for 90 days.

2: 30*2
5: (2 + 3) * 50

Front 42

What is mark-to-market?

Back 42

daily process of adjusting the margin in a futures account

Front 43

What is the conversion factor for a future contract of treasury bond?

Back 43

The long pays the futures price at expiration times the conversion factor.

Front 44

What is the time value of an option?

Back 44

option value = intrinsic value + time value

Front 45

Draw the profit/loss diagrams for call, put, covered call and protective put.

Back 45

LOS 62

Front 46

What is the lower and upper bounds for European Call?

Back 46

lower bounds:
c_t ≥ max[0, S_t - X / (1 + RFR)^(T-t)]
upper bounds:
S_t

Front 47

What is the lower and upper bounds for American Call?

Back 47

lower bounds:
C_t ≥ max[0, S_t - X / (1 + RFR)^(T-t)]
upper bounds:
S_t

Front 48

What is the lower and upper bounds for European Put?

Back 48

lower bounds:
P_t ≥ max[0, X / (1 + RFR)^(T-t) - S_t]
upper bounds:
X / (1 + RFR)^(T-t)

Front 49

What is the lower and upper bounds for American Put?

Back 49

lower bounds:
P_t ≥ max[0, X - S_t]
upper bounds:
X

Front 50

What is the difference between FRA and interest rate option?

Back 50

in FRA, payments are made at expiration
in interest rate option, payments are made at the expiration of the underlying loan

Front 51

What is tenor?

Back 51

The tenor of the bond is the time remaining until the bond's maturity date.

Front 52

What is indenture and debenture?

Back 52

Indenture: Also called trust deed, is the legal contract between the bond issuer and the bondholder. It includes covenants
Debenture: A type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are documented in an indenture.

Front 53

What is Eurobond, global bond and foreign bond?

Back 53

Eurobond: issued outside the jurisdiction of any one country and denominated in a currency different from the currency of the countries in which they are sold
Global bond: similar to Eurobond
Foreign bond: Bonds issued by a firm incorporated in a foreign country that trade on the national bond market.

Front 54

What are the bonds usually in bearer form and what are the bonds usually in registered form?

Back 54

bearer: eurobonds
registered: domestic, foreign bonds

Front 55

What is capital-indexed bond?

Back 55

Capital-indexed bonds pay a fixed coupon rate that is applied to a principal amount that increases in line with increases in the index during the bond's life.

Front 56

What is sinking fund provision?

Back 56

repayment of the principal (or a portion) through a series of payments over the life of the issue

Front 57

Is interbank offered rate a single reference rate?

Back 57

No, it's a set of reference rate for different borrowing periods. e.g. 3-month LIBOR

Front 58

What is Shelf-registration?

Back 58

A shelf registration allows certain authorized issuers to offer additional bonds to the general public without having to prepare a new and separate offering circular.

Front 59

Are sovereign bonds secured?

Back 59

No, but sovereign bonds are backed by taxing power of the country

Front 60

Is Repo collateralized?

Back 60

Yes, the securities lent can be considered the collateral posted

Front 61

Where would secondary market bond transactions take place?

Back 61

in dealer markets

Front 62

What kind of bonds are more sensitive to changes in YTM?

Back 62

Bonds with lower coupon rates and longer maturities are more sensitive

Front 63

How to calculate full price of a bond and accrued interest?

Back 63

full price = par * (1 + YTM) ^ (t/T)

par: par value of the bond on the last coupon date
t: number of days from the last coupon payment date
T: number of days between the last coupon payment date and the next

accrued interest = coupon payment * t / T

Front 64

How to calculate bond price using spot rate?

Back 64

CPN_1 / (1 + S_1) + CPN_2 / (1 + S_2)^2 + ... + (CPN_N + FV_N) / (1 + S_N)^N

S_i is spot rate for i-th period

Front 65

Which price is usually quoted by bond dealers?

Back 65

flat price (clean price)
not full price (dirty price)

Front 66

What are the two axis of yield curve? What is par bond yield curve?

Back 66

y: YTM
x: term
par curve is calculated from spot curve to reflect a hypothetical bond whose PV is FV

Front 67

What is the effect of change of YTM for bond?

Back 67

short investment horizon: market price risk > reinvestment risk
long investment horizon: reinvestment risk > market price risk

Front 68

How a bond's maturity, coupon, embedded options, and yield level affect its interest rate risk?

Back 68

1. an increase in a bond's maturity will usually increase its interest rate risk
2. increase in the coupon rate will decrease its interest rate risk
3. increase (decrease) in a bond's YTM will decrease (increase)
4. Adding either a put or a call provision will decrease a straight bond's interest rate risk

Front 69

What is the limitation of portfolio duration?

Back 69

it makes the assumption of parallel shift (every bond in the portfolio must change by the same amount).

Front 70

What will affect spread risk?

Back 70

1. credit migration risk / downgrade risk
2. market liquidity risk

Front 71

What does the corporate bond yields comprise?

Back 71

real risk free rate, expected inflation rate, credit spread, maturity premium, and liquidity premium

Front 72

What is the difference between fees for PE and hedge fund?

Back 72

The management fee for private equity funds is based on committed capital whereas for hedge funds the management fees are based on assets under management.

Front 73

Is derivative market more liquid or less liquid compared with underlying spot market?

Back 73

More liquid because of lower capital requirement

Front 74

How to calculate the payment to the long at settlement for FRA? for A * B FRA

Back 74

[(notional principal) * (floating - forward) * (days / 360)] / [1 + floating * (days / 360)]

days = number of days in the loan term (B-A)*30 days

Front 75

What is nonstandard FRA called?

Back 75

Off-the-run FRA

Front 76

What is the day count convention used for options?

Back 76

365

Front 77

What is put-call parity?

Back 77

portfolios with identical payoffs must sell for the same price to prevent arbitrage
pull-call parity could be constructed by combining a fiduciary call and a protective put
fiduciary call: combination of a pure-discount, riskless bond that pays X at maturity and an European call with exercise price X
protective put: combination of a stock longing position
with an European put option
c + X/(1+RFR)^t = p + S