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IMC - Unit 2 > 12. Fixed Income > Flashcards

12. Fixed Income Flashcards

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1
Q

What 2 things do investors of money markets try to manage?

A
  1. Their liquidity
  2. And cash positions
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2
Q

What are Treasury Bills (T-Bills)?

A

ST (<1yr to maturity) govt securities that are issued at a discount.

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3
Q

What are T-Bills used to manage?

A

The amount of cash in the banking system.

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4
Q

How risky are T-Bills considered to be?

A

Usually considered default-risk free.

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5
Q

T-Bill yield =

A

(Par value - purchase price) / purchase price

x

365 / Days to redemption

x 100%

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6
Q

To calc true compounded annualised return on T-Bill investment =

A

(Par value - purchase price) / purchase price + 1

^ (365/D) - 1

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7
Q

Retail & wholesale banks have traditionally balanced customer deposits & loan demand where?

A

In the interbank mkt.

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8
Q

The min deposit in the sterling interbank mkt is usually £XXX and is ____.

A
  • £500,000
  • unsecured
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9
Q

What is LIBOR?

A

London Inter-bank Offered Rate: rate at which banks lend to one another for the ST.

Used more as reference point.

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10
Q

What is LIBID?

A

London Inter-Bank Bid: rate at which banks are prepared to accept ST deposits.

Used more as reference point.

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11
Q

What is SOFR?

A

New US benchmark released by US Federal Reserve in Apr 2018: a measure of the cost of interbank overnight borrowing secured by US Treasury securities.

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12
Q

What is SONIA?

A

Sterling Overnight Index Average: based on actual transactions & reflects the average of int rates that banks pay to borrow sterling overnight from other financial institutions.

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13
Q

What are certificates of deposit (CDs)?

A

Tradeable time deposits issued by depositing institutions e.g. commercial banks.

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14
Q

What are typical maturities of CDs in the UK?

A

1m to 1y.

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15
Q

What denominations are CDs issued in, and with what min value?

A
  • £10k
  • £100k
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16
Q

CDs are ___, meaning they can be sold from one investor to another.

A

negotiable

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17
Q

What is Commercial Paper (CP)?

A

Unsecured ST promissory notes, issued at discount from their par value.

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18
Q

What are typical maturities of CPs in the UK?

A

7d to 1y.

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19
Q

What are FRNs? aka variable rate bonds

A

Floating rate notes: issued at par but have a coupon that is linked to to a pre-specified mkt rate

e.g. 6m SONIA + a margin.

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20
Q

On FRNs, what is regularly reset at mkt rates?

A

The coupon.

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21
Q

When FRNs are issued wit h a drop-lock, what does this mean?

A

Min value for coupln is set and if coupon rate falls below this min, issue is converted into a fixed-rate issue.

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22
Q

What is a gilt?

A

UK govt liability in sterling, issued by HM Treasury & listed on LSE.

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23
Q

How are gilts issued and what does the DMO do?

A
  • auction
  • shortly before it intends to sell some bonds, will issue a formal notice detailing how much they are looking to raise, when gilts will mature, & what coupon will be.
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24
Q

How often does the govt pay the coupon on gilts?

A

Every 6m.

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25
Gilt issues are categorised according to their remaining maturities. What are they? [4]
- Long: > 15 yrs - Medium: 7 - 15 yrs - Short: < 7 yrs - Ultra-short: < 3 yrs
26
Undated stock price =
Coupon / Required yield (as decimal)
27
What is Gilt Strips?
Separate Trading of Registered Interest & Principal Securities.
28
Stripping a gilt is what?
Breaking it down into its individual cashflows, which can be traded separately as zero-coupon gilts. e.g. 3 yr gilt = 7 individual cashflows (Cs x 6 & P)
29
What happens on the repo mkt?
Sale & repurchase of securities (gilts) at an agreed future date & price.
30
What is the buyback price on the repo mkt?
Original price + int at the 'repo rate'.
31
What do repos afford the seller, and the counterparty?
- cheap way of borrowing cash - way of borrowing securities, perhaps to settle a short position.
32
What is the usual term for repos?
Up to 1 yr.
33
Gilt prices are quoted 'clean', i.e. ?
Exc. accrued interest
34
When gilts are purchased, the actual price paid is known as the 'dirty' price, i.e. ?
Clean price plus any accrued interest
35
What is an ex-dividend stock? And give an example of when a stock is said to be ex-dividend.
- When investor is not entitled to coupon payment. - If an investor purchases a gilt 7 days or less before next coupon.
36
What is it called when an investor is entitled to the next coupon payment?
Cum-dividend
37
What does the gross redemption yield (GRY) represent? aka yield to maturity (YTM), or total measure for a bond investment.
The yield an investor would get if they held the gilt until maturity (assuming all coupons are invested at the same rate).
38
GRY = IRR of bond cash flows =
Bond price = C / (1+R)^1 + C / (1+R)^2 + C / (1+R)^3 + (C+P) / (1+R)^n C = coupon P = principal i.e. par / nominal value n = no. of yrs to maturity
39
GRY only accurate if what 2 conditions are met?
1. Gilt is held to maturity 2. All coupons recv prior to maturity are reinvested at GRY.
40
Index-linked bonds are also known as ___ in the UK and ___ in the US.
- ILGs - TIPS (treasury inflation-protected securities)
41
Real return rate =
Nominal rate (rate adj for rise in inflation) - inflation rate
42
For an 8 month lagged ILG, each coupon payment is determined by what?
RPI 8 months prior to its payment date
43
8 month lagged ILG: ILG coupon =
Semi-annual coupon x RPI(m-8) / RPI (B)
44
8 month lagged ILG: ILG principal =
£100 x RPI(m-8) / RPI(B)
45
What does a corporate bond indenture specify? [3]
- The rights of the bondholders - Obligations of issuing firm - Special characteristics of each issue
46
What does a sinking fund provision require?
The firm 'retires' (buys back) a certain proportion of the bond issue throughout the life of the bond.
47
What are protective covenants and what is their purpose?
- Specific limitations on the future actions of the issuing firm identified in the bond indenture. - To ensure the stream of income required to meet coupon & principal payments are not exposed to undue risk.
48
Name 2 examples of protective covenants.
- proportion of earnings that cab be paid to SHs - amount of additional debt that cab be raised - amount execs can pay themselves
49
What is a call provision?
Usually allows the firm to redeem the issue at its discretion on pre-specified dates at pre-determined prices.
50
When might a firm use a call provision?
If int rates fall below coupon rate, retiring the issue that pays a higher coupon and issuing a debt at a lower rate.
51
With callable bonds, investor is subject to greater ___ than non-callable bonds.
reinvestment risk
52
What does a put provision do?
Allows the investor to sell the bond back to the issuer at a pre-specified price.
53
What provisions are only beneficial for the firm, and what provisions are only beneficial to the investor?
- call provisions - put provisions
54
Debentures are usually secured by a ___ ___ on the assets of a company.
floating charge (fixed charges are legal rights over a specified asset such as machinery).
55
What are zero-coupon bonds, what are their advantages to issuing firms and investors?
- Corporate bonds that pay no coupon, only a redemption value - don't require cash flows during bond life - no reinvestment risk (but price risk)
56
What are Eurobonds?
A bond that is denominated in a currency other than the home currency of the country or mkt in which it is issued.
57
What are contingent convertible (CoCo) bonds?
A debt that is converted into equity if a pre-specified trigger event occurs e.g. capitalisation falling below a certain level.
58
What is the intention of CoCos?
To be a readily available source of capital in time of crisis when private investors are usually unwilling to provide additional external capital to banks.
59
What are the 2 defining characteristics of a CoCo?
1. mechanism by which losses are absorbed 2. trigger that activates that mechanism
60
CoCo triggers can either be ___ rules or ___ rules.
- mechanical - discretionary (aka PONV - point of non-viability triggers)
61
What are the 2 ways a CoCo can raise a bank's equity?
1. A **conversion-to-equity CoCo** raises capital ratio by converting bond into equity at a pre-defined conversion rate. 2. A **principal write-down CoCo** raises equity by incurring a write-down.
62
For a given coupon rate, a CoCo with a ___ trigger level is more favourable to the holder, since the holder is ___ ___ to suffer losses when conversion is triggered.
- lower - less likely
63
In general, the higher the coupon payment, the ___ the price of the security will be.
higher
64
The current price of a fixed-income security should be what?
The sum of the PV of its remaining coupons & principal.
65
Bond price (PV) =
C / (1+R)^1 + C / (1+R)^2 + C / (1+R)^3 + P + C / (1+R)^n c = coupon p = par value (usually £100) r = discount rate or investor's required return
66
- Coupon < GRY, price? - Coupon > GRY, price? - Coupon = GRY, price?
- <£100 - > £100 - = £100
67
There is an ___ relationship between bond price and yield.
inverse
68
What are the 2 key factors that affect the sensitivity of a bond's price to a change in investor's required return?
- **term to maturity of the bond** - longer the term, greater the % change in price - **size of coupon** - lower the price of coupon, more sensitive to changes in required return than bonds that pay larger coupons
69
If bond portfolio managers think int rates might rise, they might try to hold what types of bonds? [2] Why?
Less-sensitive ones: - higher coupon payments - shorter maturities - to defend against bond price falls that will accompany a rise in int rates
70
What is the Macauley duration?
One measure of bond price sensitivity aka economic life of bond
71
Macauley duration D =
(PV1/B x1) + (PV2/B x2) + (PV3/B x3)
72
In general, as the maturity of a fixed-income security increases, its duration ___
increases.
73
What can modified duration (MD) be used to approximate?
The change in a bond's price given a small change in the the required yield.
74
Modified duration MD =
D / 1+R
75
What does the duration calculation assume and what is the risk known as of this not happening?
- future coupons can be reinvested at the current redemption yield - reinvestment risk
76
Approximate change in bond price =
(-MD) x (DR) x (B) DR = change in required yield in % points B = PV of bond
77
The relationship between price and yield is ___, not ___.
- convex - linear
78
___ risk and ___ work in opposite directions with respect to ___ ___ changes.
- price risk - reinvestment risk - interest rate changes
79
Name 4 other risks associated with investing in bonds.
- **credit risk**: credit rating of bond issuer falls - **default risk** - **inflation risk** - **currency risk** - **call risk**: if bond is callable ,risk that when rates fall, bond will be redeemed early by issuer, forces cash to investor sooner than expected at time when reinvestment returns are lower.
80
Bonds that are rated ___ or above are known as ___ ___, while those related below are known as ___ ___ or ___-___ or ___.
- BBB- - 'investment grade' - 'below-investment grade' - 'high-yield' - 'junk'
81
What is the general ranking for bonds in default? [3]
1. senior secured 2. senior unsecured 3. subordinated
82
Interest yield =
Coupon / Price (clean)
83
NRY =
Cnet / (1+R)^1 + Cnet / (1+R)^2 + Cnet / (1+R)^3 + Cnet + P / (1+R)^n
84
The yield curve shows the relationship between ___ and ___.
yield and maturity
85
The **pure expectations theory** of the term structure of interest rates states that in equilibrium, what?
The LT rate is the geometric average of today's ST rate + expected ST rates in the future.
86
Pure expectations theory formula is:
(1+R)^2 = (1+R)^1 x (1+R)^2
87
Forwards are?
the implied ST future int rates
88
Spots are?
single rates from now up to a specified future point in time
89
The yield of a bond is?
a complex (weighted average of the spot rates)

IMC - Unit 2 (10 decks)

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