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Unit 2: Securities > 2.3 Debt Valuation > Flashcards

2.3 Debt Valuation Flashcards

1
Q

What is a yield?

A

Return on a bond

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2
Q

What are 4 other names for a Flat Yield?

A

Interest yield
Simple yield
Coupon yield
Running yield

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3
Q

How do we calculate flat yield?

A

(Gross annual coupon/market price) x 100%

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4
Q

What are the limitations of the flat yield calculation?

A
  • only considering coupon (investor holding bond to maturity cannot get an indication of capital gain/loss)
  • uses gross coupon; doesn’t take into consideration impact of tax
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5
Q

In what cases would a flat yield calculation be used?

A
  • purely income-seeking non-taxpayers (not planning to hold bond to maturity)
  • irredeemable (undated) bond
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6
Q

What is an irredeemable bond?

A

aka. undated bond

bond with no known redemption date

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7
Q

What is the relationship between the yield and the coupon?

A
  • if price is same as nominal value; yield and coupon should be the same
  • if price of bond > NV: Coupon>FY
  • if price of bond < NV: Coupon<FY
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8
Q

What is Gross redemption yield (GRY)?

A
  • considers annual return due to income and gain through to redemption
  • annualised total return for bond held to maturity
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9
Q

What is Gross redemption yield (GRY) also known as?

A

Yield to maturity (YTM)

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10
Q

How doe we calculate of GRY?

A

Flat yield + Profit/loss at redemption

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11
Q

How do we calculate profit/loss at redemption

A

(Difference between price and nominal value / number of years till redemption)/ price x 100%

if negative = capital loss

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12
Q

What is relationship between Price, NV, Coupon, FY and GRY

A

If Price > NV: Coupon > FY > GRY (capital loss)

If Price < NV: Coupon < FY < GRY (capital gain)

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12
Q
A
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13
Q

What is the Net redemption yield?

A

Considers impact of tax of GRY (YTM)

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14
Q

How to calculate NRY?

A

Apply income tax to the coupon - not expected to calculate in the exam

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15
Q

How do we price bonds?

A

Work out value of future cashflows by discounting future CFs to calculate PV

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16
Q

What is the PV formula?

A

PV = FV/(1+r)^n

r = discounting factor (interest rate)

n = number of period for which you are discounting

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17
Q

What should we take into account when discounting a bond?

A

The CF in the final year will always be that year’s coupon + the redemption value

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18
Q

What is the clean price of a bond?

A

The quoted price

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19
Q

What is the dirty price of a bond?

A

The clean price + any accrued interest

20
Q

Difference between cum coupon period and ex coupon period?

A

Cum coupon period - if someone buys a bond off smn in this period buyer gets next coupon payment

ex coupon period - if smn buys a bond off smn at this period seller gets next coupon payment (eg. a few days before next coupon payment)

21
Q

Why are bonds with a low coupon attractive?

A

Coupon received from most bonds is generally taxable, but any gain made on redemption (or subsequent sale) is not taxable

This makes bonds with a low coupon attractive to higher rate taxpayers, as the price may be lower than par, resulting in a part of the return coming in the form of a tax-free capital gain

22
Q

What is the ex-coupon period for a UK Gilt?

A

Typically 7 business days

23
Q

What is the ex-coupon period for a bearer bond?

A

Do not typically have ex-coupon periods

24
Q

What is the relationship between clean and dirty prices of bonds in cum/ex coupon periods?

A

Cum coupon period: Dirty price always higher than clean price

  • in this period the buyer gets the whole coupon for the 6 month (or 1 yr period) but a portion of that should go to seller
  • seller factors this in and adds on top of clean price

Ex coupon period: Clean price higher than dirty

  • because buyer of the bond doesn’t get the few days worth of interest as they don’t get the coupon; seller owes them that portion of interest and does so by discounting price
25
Q

How do we calculate accrued interest?

A

𝐴𝑐𝑐𝑟𝑢𝑒𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × (𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑓𝑟𝑜𝑚 𝑙𝑎𝑠𝑡 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 /
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑)

  • work out interest of the nominal and multiply by the fraction (days/days in payment period)
26
Q

How do we work out clean price?

A

Divide the nominal by 100 (our assumption) to get the number of bonds

Multiply this by the price at which you are buying

27
Q

How do we calculate number of actual days?

A

Start: day after last coupon paid

End: settlement day

28
Q

What is a spread?

A

Difference in yield on one investment and yield on another

29
Q

What are spreads measured in?

A

basis points (0.01%)

100 basis points = 1%

30
Q

What is the inter-bank market?

A

Market where there are reference for interest rates that banks can deposit/borrow from each other

31
Q

What is LIBOR?

A

London inter-bank offered rate

  • benchmark for inter-bank borrowing
32
Q

What is LIBID?

A

London inter-bank bid rate

  • benchmark for deposits
33
Q

What are spread to government securities?

A
  • aka. default spreads
  • looks at yield between company and government’s bond (usually for companies in good standing)
34
Q

What is spread to LIBOR?

A

Using LIBOR as benchmark

35
Q

What is spread to swap rates?

A
  • measures spread between 2 yields, one is where the benchmark is the swap rate
  • for longer term interest rates
36
Q

What is simple interest?

A

Calculation of the simple (annual) interest income on corporate debt

  • no compounding
37
Q

How do we calculate simple interest?

A

Market price/price per nominal to get number of bonds

interest income (coupon) x number of bonds

38
Q

What is the conversion ratio for convertible loan stock?

A

The number of shares that each £100 of nominal value of the bonds can convert into

39
Q

How do we calculate conversion ratio of convertible loan stock?

A

nominal value/conversion price of shares

40
Q

How do we calculate conversion price on convertible loan stock?

A

Market price/number of shares

41
Q

how do we calculate conversion premium on convertible loan stock?

A

Conversion price - current share price

  • can express this difference as a percentage of the current share price
42
Q

How do interest rates affect bond prices?

A

inverse relationship

  • when interest rates rise bond prices fall
  • this is because investors demand higher yield when interest rates increase
  • if coupon is fixed the only way to achieve this is to lower price
43
Q

Which bonds are more volatile - longer dated or shorter dated?

A

The longer the time to redemption the more volatile the bond is - more sensitive to interest rate movements

44
Q

what is the relationship between price of a bond and time to redemption?

A

Longer time to redemption = more uncertainty = higher risk = lower price

45
Q

Which bonds are more volatile?

A
  • long dated
  • low coupon (lower income
  • low yield
46
Q

What is modified duration?

A
  • A measure of volatility
  • calculates approx. percentage change in bond price for 1% change in interest rates
  • bonds w higher modified duration are more volatile
47
Q

What is a yield curve?

A

Yield against maturity for a particular benchmark bond

  • looks at current yield available to investors across different maturities (time horizons)
48
Q

What are the different shapes of the yield curve and what do they indicate?

A

Normal: Upwards sloping

  • linked to liquidity preference theory which states that long-dated bonds will have higher yields

Inverted: Downwards sloping

  • shorter dated bonds have higher yields
  • this suggests expectation of falling rates
  • linked to recession

Unit 2: Securities (13 decks)

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