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FIN3703 > Debt Market > Flashcards

Debt Market Flashcards

1
Q

What is a bond?

A

A promissory note or security issued by a borrower (business or government unit) that obligates the issuer to make specified fixed payments to the holder over a specific period (usually long term)

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2
Q

What are the features of a bond?

A

1) Par Value: Stated face value of the bond
2) Coupon payment: Interest($) paid to the lender each period (Can be made annually, semi-annually, quarterly)
3) Coupon rate: Coupon payment divided by the par value
4) Maturity date: The date whereby the par will be repaid
5) Price: Price at which the bond can be bought or sold (Sold at par, premium, or discount)
6) Yield to maturity: Yield of the bond if one holds till maturity, assuming that each coupon is reinvested at the same rate (Basically - risk free rate + all the other factors)

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3
Q

What is a zero-coupon yield?

A

Yield on a zero-coupon bond.

*Equation in notes

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4
Q

Facts about bonds?

A

1) Bond price and market interest rates are negatively related
- When market interest rates increase, bond price will decrease

2) Bond with a longer maturity is more price sensitive than a bond with shorter maturity when interest rates changes, c.p
3) Bond with a lower coupon rate is more price sensitive than a bond with higher coupon rate
4) For any bond, a given increase in interest rate will cause a smaller price change than a decrease in interest rate of the same magnitude (rmb the convexity of the bond curve)

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5
Q

2+3) How to tell which bond is more volatile if the bond has higher coupon rate and longer maturity?

A

Look at the Duration/Maturity

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6
Q

How do you determine the default-free, short-term, real interest rate of a specific bond?

A

1) Anticipated inflation: Price of bond lower if anticipated inflation is high
- Inflation will erode cash flows
- Inflation will cause interest rates to increase, causing bond prices to decrease (Inverse relationship)

2) Term to Maturity: Longer term, more risky as it is more sensitive to interest rate changes. Thus, interest rates will be high.
3) Default/credit risk: If issuer perceived credit quality deteriorates, they will incur a higher risks, causing interest rates to increase and price of bond to drop
4) Optional features: Callable, puttable, convertible
5) Event risk, liquidity, tax status, exchange rate risk
* Value of options will be priced into bonds, depending on who the option favours

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7
Q

What are the different types of bonds?

A

1) Level-coupon bonds
2) Perpetual bonds
3) Pure discount bonds
4) Callable bonds
5) Convertible bonds
6) Floating rate bonds
7) Domestic bonds
8) Eurobonds
9) Asian Dollar bonds
10) Foreign bonds
11) Dim Sum bonds
12) Panda bonds
13) Diaspora bonds
14) Green bonds
15) Social Impact bonds
16) Catastrophic bonds
17) Pandemic bonds

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8
Q

What is a Level-coupon bond?

A

Most common type

Periodic fixed (level) coupon payments [constant coupon rate]

*Equation in slides

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9
Q

What is a Perpetual bond?

A

Pays a constant stream of coupon forever

It NEVER matures.
- Bond seller can keep the principal payment as long as he/she wants

Perpetual bond price = Cash flow (periodic coupon payment) / i (market required return)

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10
Q

What is a Pure Discount bond?

A

Zero-coupon bonds.

Bonds that make no coupon payments and is thus priced at a deep discount.

Only discount 1 cash flow back to t=0

*Equation in notes

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11
Q

What is a Callable bond?

A

Bonds that contains a call provision.

Gives the issuer the right to call the bonds for redemption before maturity.

Risk involved:
EMBEDDED PREPAYMENT RISK
- The issuer can call back the bond for pre-payment before maturity
- Causes risk to increase
- Yield will be higher as we demand a higher return to reward risk-taking
- Bond price will decrease

*If call issuer benefits, this means bad news for the bond holder

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12
Q

What is a Convertible bond?

A

Bonds that allow holders to convert bonds to stocks at a pre-specified ratio.

This favours bondholders.
WHY?
- Stocks are a long-term instrument
- There are a lot of upside potential if the stock does well

Lower yield (for convertible feature), therefore higher bond price.

If the company is doing badly, they can use contingent convertible bonds to convert debt to equity (bad for bondholders).

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13
Q

What is a Floating rate bond?

A

Bonds with coupon payments that are adjustable, normally tied to an interest rate index (e.g. LIBOR, SIBOR)

These bonds usually trade close to par.
WHY?

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14
Q

What is a Domestic bond?

A

Market of issue = currency = nationality of issuer

E.g. US$ bond placed in US by US firms
&
SIA issuing SGD bonds in SG

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15
Q

What is a Eurobond?

A

Bonds issued and sold outside the country of the currency in which they are denominated.
- Currency of the bond is different from the place it is issued

E.g. US$ denominated bonds issued in Europe and not issued in the US

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16
Q

What is an Asian Dollar bond?

A

A subset of euro-dollar bond.

Place of issue: Asia

E.g. USD bond not traded in the US, but in Asia

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17
Q

What is a Euro-yen/Euro-won/Euro-euro bond?

A

1) Euro-yen: Yen bond sold outside of Japan (Does not need to be issued in Europe)
2) Euro-won: Won bond issues outside of Korea
3) Euro-euro: Euro-denominated bond sold outside of Europe

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18
Q

What is a Foreign bond?

A

Market of issue = currency =/ nationality of issuer

  • Bond issuer must be a foreigner
  • A local cannot issue a foreign bond

Bonds issued outside of the issuer’s country, usually denominated in the currency of the country in which they are issued.

e.g. US$ bond placed in US by non-US firms

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19
Q

What is a Dim Sum bond?

A

CNY denominated bond issued outside of China by a Chinese firm.

Similar to an Eurobond but NOT an Eurobond. Not a Foreign bond.

  • Because Hong Kong is part of China

Mostly done in Hong Kong where the ‘outside of china’ is Hong Kong.

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20
Q

What is a Panda bond?

A

China’s version of foreign bonds.

Not accessible to many issuers.

A Chinese renminbi-denominated bond from a non-Chinese issuer, sold in the People’s Republic of China.

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21
Q

What is a Diaspora bond?

A

Bonds issued by governments to be sold to their emigrants in rich countries.
- Targets the affluent living overseas

WHY?

  • Emigrants are more patriotic, more informed and they understand the risk better, they have more personal interests
  • They buy the bonds, governments can raise funds to build bridges, flood control dams, clinics, schools etc. (basically develop the country)
  • Hope to incentivise these emigrants to invest in their home country
22
Q

What are the 6 different Foreign bonds?

A

1) Samurai (Japanese)
2) Yankee (US)
3) Bulldog (UK)
4) Kangaroo (AUS)
5) Maple (Canada)
6) Panda (China)

23
Q

What is a Green bond?

A

Climate bonds.

Bonds issued for environmentally-friendly investments.

  • Usually comes with tax exemptions
  • Large polluters rarely issue such bonds
  • However, these green bonds do not have much change on the environment or benefit the environment

Eg. Windfarm, solar energy, other renewable energy, zero-emission cars etc.

24
Q

What is a Social Impact bond?

A

It comes from the UK.

1) It pays for success bonds (US), social benefit bonds (AUS), and development impact bonds (Emerging nations).
2) Invest in social programs (by private service providers who are more effective and innovative than governments) - with measurable success markers

  • Private investors will receive payouts (by the government) ONLY when markers/thresholds are met
    > If targets are met, investors are paid above market interest rates and bond yield
    > If targets are not met, principal will be wiped out and bond holders will get nothing
  • Thus, these payouts given by the government must be budgeted.
  • For investors, it is more of a structured product than the bond
  • Payouts given by government but the issuance of social impact bonds are run by non-governmental organisation
25
Q

What is a Catastrophic bond?

A

Bonds that are issued to cover catastrophes, usually natural disasters.
- Covers damages and helps to rebuild the community if disaster strikes
> A structured product

  • Can be issued by insurance companies to manage their risks by sharing the risk with investors
  • Investors in the bonds get above-market yields in exchange for the high risk that principal could be wiped out by a major disaster in a specified area
  • But there has not been many instances where disasters have been severe enough to wipe out the principal of the bonds
26
Q

What is a Pandemic bond?

A

For diseases outbreaks such as Ebola.

World Bank set up a new Pandemic Emergency Financing Facility (PEF) to provide funding covering to:

1) 77 of the world’s poorest countries
2) Six possible types of viruses outbreaks such as new influenza viruses, coronaviruses (SARS) and filoviruses (Ebola)

  • PEF is funded through cash, bonds, derivatives and donations
  • Investors forgo their principal when a virus reaches a predetermined contagion level
27
Q

What is the issue of Green bonds?

A

1) What determines what is green?

E.g. Nuclear plants
- If it blows up, there will be radiation and it is no longer “green”

2) Greenwashing: Companis pretending to be green

28
Q

What do Yield Curves do?

A

Shows the graphical relationship between yield and maturity for bonds of the SAME CREDIT RATING but different maturity.

  • Usually for T-Bills and T-Bonds
  • Y-axis: Yield
  • X-axis: Maturity
29
Q

Why use T-Bills and T-Bonds for yield curves?

A

1) They have low default risk
- A credit event brings into question the borrower’s ability to repay its debt.
- Although a country can print money and repay its debt, a credit event can still occur where the country experience hyperinflation and currency depreciation.
- Leading to implicit default.
Example:
> Greece –> Unable to print money and repay its debt
> US –> Able to print money but controlled by the debt ceiling

2) No liquidity risk as they are very liquid

3) Bootstrapping: A procedure used to extract zero yields from coupon paying bonds.
- Not enough zero-coupon bonds to formulate yield curve, thus, use coupon paying bonds to get zero-coupon yield

30
Q

What are the different shapes of Yield Curves?

4

A

1) Upward sloping
- Normal yield curve
- Longer maturity, carry more risks
- Due to liquidity premium (An additional value demanded by investors when any given security cannot be easily and efficiently sold or otherwise converted into cash for its fair market value.)

2) Downward sloping
- Could be caused by recession, economy looking bleak
- Long-term investors are willing to accept shorter interest rates

3) Flat shaped
- Little difference between short-term and long-term rates for bonds of the same credit quality.
- Often seen during transitions between normal and inverted curves.

4) Humped shaped
- When the interest rates on medium-term fixed income securities are higher than the rates of both long and short-term instruments.
- Also, if short-term interest rates are expected to rise and then fall, then a humped yield curve will ensue.

31
Q

What are the different types of US Treasuries?

A

1) Treasury Bills
2) Treasury Notes
3) Treasury Bonds
4) Treasury Strips
5) Municipal Securities (Munis)

32
Q

In general, how do these US Treasuries function?

A

1) Issued by the US Treasury to finance the national debt + other federal government expenditures
2) Backed by the full faith and credit of the US government and are seemingly default free/risk-free
3) Pay relatively low yields due to their low risks
4) Assumed to have a face value of $1,000 and semi-annual payment (Other than bills)

*Note:
> Treasury issues fiscal policies
> Central bank issues monetary policies.

33
Q

What are Treasury Bills?

A

Money market instrument.

Discount security.

Maturity: One year or less (short-term)

Short-Term zero coupon discount instruments.
- Discount yield are not applicable

34
Q

What are Treasury Notes?

A

Coupon Security.

Semi-annual coupons.

Maturity: Between 2 to 10 years (medium term)

*Note that Treasury Notes and Treasury Bonds are usually not differentiated, only in the US.

35
Q

What are Treasury Bonds?

A

Coupon Security.

Semi-annual coupons.

Maturity: Between 10 to 30 years (Long-term)

*Note that Treasury Notes and Treasury Bonds are usually not differentiated, only in the US.

36
Q

What are Treasury Strips?

A

Separate Trading of Registered Interest Paying Security.

A treasury security in which the periodic interest payment is separated from the final principal payment.
(stripping out the cash flow)

Similar to a 0 coupon bond

Effectively, this creates 2 sets of securities.
1) Semi-annual interest payment
2) Final principal payment
> Number of securities = 2*(Number of years) + 1 (Final principal payment)

Created by the US treasury in response to separate trading of treasury security principal and interest.

37
Q

What are Municipal Securities (Munis) aka Municipal Bonds?

A

Local authority bonds.

They are not issued by the US Treasury.
Instead, they are issued by state and local governments and authorities.
- Thus, they are not default free.
- It does default from time to time.

It is to fund temporary imbalances or LT capital outlays such as school construction, public utility construction or transportation systems.

Tax receipts or revenues generated are the sources of repayment.

Attractive to household investors because in most cases, interest income (but not capital gains) are tax exempt.
- When investors sell them before maturity, they can be taxed for capital gains.

38
Q

Why Singapore no need to finance its expenditures through issuance of government bonds?

A

Singapore operates on a balanced budget policy and often enjoys budget surpluses (as far as possible).

  • Government does not spend beyond tax income
  • Therefore, they do not need to incur debt by issuing T-Bills or T-Bonds
  • They do not tap into the reserve unless needed (E.g. sub-prime crisis & COVID-19)
39
Q

Why were the Singapore Government Securities initially issued for?

A

To meet banks’ needs for a risk-free asset in their liquid asset portfolios.
- To meet their MLA

40
Q

What are the objectives behind developing the SGS market?

A

To enhance the efficiency and liquidity of the SGS market as part of its strategy to develop Singapore as an international debt hub.

Since then, the SGS market has grown significantly, making it one of the fastest developing bond markets in Asia.

1) Provide a liquid investment alternative with little or no risk of default for individual and institutional investors since SG govt bonds are rated AAA.

2) Establish a liquid government bond market which serves as a benchmark for corporate debt securities market (for corporates to issue their bonds as well)
- Government bonds will help in the ease of pricing

3) Encourage the development of skills relating to fixed income securities and broaden the spectrum of financial services available in Singapore

41
Q

How often do MAS issue T-bills and bonds?

A

1) MAS bills (4-week and 12-week)
2) T-bills (6-month and 1 year)
3) SGS bonds (2-year to 30-year)

42
Q

What are SINGA bonds for?

A

To pursue long-term infrastructure, issue these bonds so people will “pay” for the infrastructure they will use in the future
> Lessen the burden on current taxpayers

43
Q

Why was there a potential conflict of interest by issuing SGS?

A

Technically speaking the treasury shld be the one to issue the bond to finance government spending + control the ability for central banks to print money to repay bondholders

BUT in SG, MAS is basically the government

44
Q

What are the SGS bonds for?

A

For institutional gains, not for retail investments

45
Q

What is the current status of SGS?

A

As of December 2020: the size og the SGS market is 60% of SG’s GDP (500 billion SGD)

46
Q

How do MAS-bills and Singapore’s T-Bills work?

5

A

1) Minimum denomination is $1,000
2) Zero-coupon, issued and traded on discount basis (Does not pay coupons)
3) Shorter tenure

4) Involves competitive and non-competitive bidding
- Total non-competitive allotment is subject to a limit of 40% of issue
- Non-competitive bids are allotted first
- Followed by competitive bids where lowest yield are allotted first followed by highest yields

5) Issued by auctioning

47
Q

Why do investors want non-competitive bids?

A

They are desperate to get the bonds/bills at any yield/price/return

  • Maybe to cover their short position
  • Easier to get back “in full”
  • Need the most recent T-bills as they are the most liquid (Keep “on-the-run” T-Bills)

Sometimes they do not have enough knowledge about the market.

48
Q

How do T-Bonds work?

A

1) Duration: 2, 5, 10, 15, 20, 30 years
2) Minimum amount: $1,000
3) Semi-annual payment (Coupon issue)

4) Total non-competitive allotment is subject to a limit of 40% of issue
- Non-competitive bids allotted first, then competitive bids from lowest to highest yields
- If 40% is exceeded, the cap will be pro-rated among the non-competitive bidders to ensure the 40% remains

5) Longer tenure
6) Non-negotiable
7) Cannot be traded in the secondary market
8) Little to no capital gains, but rather gains in the form of coupon payments

49
Q

How are T-Bills and T-Bonds auctioned?

A

1) Closed bids (no one knows who bid and how much they bid)

2) Bidding only for primary dealers (big banks)
- No retail investors
- No small banks
- No insurance companies

*Refer to notes

50
Q

What is the Singapore Savings Bond?

A

A special type of SGS with features that make them suitable for individual investors.

1) Provides a long-term savings option that offers safe returns, for Singaporeans
2) Backed by the full faith of the Singapore government
3) New issue every month (for at least years)
4) Non-negotiable (cannot be traded in the secondary market)

5) They are 10-year bonds but redeemable at par (principal) in any month (paid out on the 1st business day of every month)
> Similar to a 1 month fixed deposit
> Not much risk

6) CDP account needed (Same clearing house as the stock market)
7) Application through local banks’ ATM or internet banking (min $500 and max $50,000)
8) Holding limit: $200,000
9) Redeem through local banks
10) Longer the holding period, higher the rates
11) When bank’s interest rate are inching up, we rather leave our money in the bank to gain interests so demand for SSB will decrease (vice versa)

FIN3703 (12 decks)

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