Asset Classes 2 - Bonds

Question 1

What is a Eurobond?

Answer 1

Denominated in a currency other than the home currency of the country or market in which the bond is issued.

Question 2

What is a double dated bond?

Answer 2

Issued with two maturity dates. The issuer can give notice and choose to redeem the bond on any day between the first and final maturity dates

Question 3

What are the difference in conventions for bond duration between FT and DMO?

Answer 3

FT
Shorts <5Y
Mediums 5-15Y
Longs >15

DMO
Shorts <7Y
Mediums 7-15Y
Longs >15

Question 4

What are drop locks & caps for FRNs? and what is mini-max bond?

Answer 4

• Drop lock = interest rate becoming fixed if it falls to a specified level
• Cap = if interest rates rise, the coupon also rises, but not beyond the ceiling
• Mini-Max = A collared FRN with a floor and a ceiling

Question 5

How do Tax Authorities treat Zero Bonds?

Answer 5

Tax authorities will deem the investor to have received a notional amount of income each year and tax them on that

Question 6

What is the difference between subordinated and unsubordinated debt?

Answer 6

• Unsubordinated bonds (senior debt) carry an unconditional promise that they will be repaid before the creditor’s other obligations
• Subordinated bonds (junior debt) rank after unsubordinated bonds for repayment.

Question 7

What are common covenants?

Answer 7

• limiting further debt and its priority for repayment,
• restricting the payment of dividends
• restricting the sale of assets

Question 8

What is the Central Government Net Cash Requirement (CGNCR)

Answer 8

The CGNCR represents the shortfall between:

• the central government’s revenues (what money it takes in, in the form of taxes and duties), and
• what it spends on running the country (eg, paying state benefits, and infrastructure projects, such as road building).

Question 9

What is the Public Sector Net Cash Requirement?

Answer 9

It is equal to the sum of:

• the central government net cash requirement (CGNCR)
• the local government net cash requirement (LGNCR), and
• the public corporations net cash requirement (PCNCR).

Question 10

What is the other name for local authority bonds?

Answer 10

Corporate Stocks

Question 11

What are the 2 types of local authority bonds?

Answer 11

• Local Authority Fixed Stocks – these fixed-rate investments are not marketable Thus, investors must hold stocks until maturity unless the local authority is willing to redeem early,
• Local Authority Negotiable Loans (Yearlings) – have a life of no longer than two years, are issued at par, and are marketable

Question 12

What are the different types of German govies?

Answer 12

• bearer Bunds with maturities of between ten and 30 years
• medium-term notes such as Bobls for between three to five years, and
• Schatz with maturities of two years.

Question 13

What are the different types of French govies?

Answer 13

• Obligations Assimilables du Trésor (OATs) = 2-50years
• Bons du Trésor à Taux Fixe (BTFs) = up to 12 months.

Question 14

What is the maturity of most Japanese gov debt?

Answer 14

10 years

Question 15

What is the minimum denomination of UK T-bills?

Answer 15

£500K

Question 16

What is the tax position on corporate bonds?

Answer 16

• Interest is paid gross, at specific intervals which will be set out in the bond’s terms (eg, usually half years for UK corporate loans).
• CGT is not chargeable, providing that it is a qualifying corporate bond (QCB). Broadly, a QCB is one which is interest-paying, rather than a convertible; and is denominated in sterling.

Question 17

What is a debenture?

Answer 17

corporate bonds which are backed by security, (eg, land or buildings)

Question 18

What are Permanent Interest Bearing Shares (PIBS)?

Answer 18

PIBS are issued by building societies with the following features?

• Interest is paid gross at a fixed rate, half-yearly and is taxable.
• Building societies are under no obligation to pay the interest in any one year, nor to roll it over to the next year
• PIBS are irredeemable. They are only repaid by an issuing building society on liquidation, in which case the PIBS holders will be the last creditors to be repaid.
• Investors do not pay CGT on disposal, as the shares are classified as QCBs.
• PIBS are fairly illiquid

Question 19

Bond running yield calculation?

Answer 19

Gross Coupon / Market Price

Question 20

Holding Period Return Calculation for a bond?

Answer 20

(Price at Maturity - Purchase Price) / Purchase Price

Can be annualized by dividing outcome by number of years to maturity

Question 21

What is the Gross Redemption Yield?

Answer 21

Running Yield + Annualized HPR

Question 22

What types of bonds are more sensitive to changes in interest rates?

Answer 22

• Longer-dated bonds are more sensitive to interest rate changes than their short-dated counterparts.
• High coupons damp down volatility while low or zeros increase volatility.

Question 23

What is the measure for bond interest rate sesitivity and its calculation?

Answer 23

Macaulay duration (or, simply, its duration).

= (∑ (NPV of cash flows * time to cash being recieved) / ∑ NPV of the cash flows to be received

Question 24

What is the formula for modified duration?

Answer 24

-macaulay duration / 1 + GRY

Question 25

How do you calculate the change in a price of a bond with the modified duration?

Answer 25

% change in price of bond = (− Modified duration × % change in the yield)

Question 26

How can a bond issuer enhance its credit rating?

Answer 26

arrange for another organisation (generally one with very strong finances) to guarantee the debt, called a guarantor.

Question 27

Which 4 ways are bonds issued in the primary market?

Answer 27

* **Offer for sale** – a syndicate of banks buys the bonds en bloc from the issuer and resell them to investors. Syndicate banks can charge higher prices * **Fixed price re-offering** – the lead manager and the syndicate buy the bonds simultaneously and agree to sell at the same price for a period. * **Competitive auction** – This type of issue is used less frequently (apart from for government bonds). * **Private placing** – the issuer sells bonds directly to a smaller number of professional investors.

Question 28

What are the settlement dates for Gilts and Corporate Bonds?

Answer 28

Gilts T+1 Corporate T+2

Question 29

Why is it difficult to construct bond indices?

Answer 29

1. The universe of bonds is much larger than equities, with securities offered in a range of maturities combined with issuers (both from the government and corporate sectors) who have a variety of long-term credit ratings. 2. Many bond indices are issuance-weighted, meaning that the index represents the most indebted issuers. 3. Bonds have other clauses such as calls, convertibility or sinking fund features that make it difficult to create a suitable benchmark that can be used to assess all the bond funds available to investors. 4. As older issues are redeemed, new ones may be issued with characteristics that may differ from the ones they replaced. This means the universe of securities, from which indices are created, will change more frequently to represent the changed population in the bond universe.

Question 30

How are bond indices weighted?

Answer 30

* Most bond indices are weighted by total issuance value. * This means that the more debt that a country or company takes on, the greater the allocation in the index

Question 31

What are the strategies used in active bond management?

Answer 31

* DURATION SWITCHING alters the portfolio duration with expected changes in interest rates. For example, an investor expecting a fall in interest rates may increase the duration by replacing low- with high-duration bonds. * RIDING THE YIELD CURVE involves buying a long term bond but selling it before maturity to profit from a declining yield over the bond’s life. * BOND SWITCHING (or swapping) exchanges one bond for another. There are three main types: a) ANOMOLY SWITCHING moves between two bonds similar in all respects apart from their yields and/or prices. This pricing anomaly is exploited by switching away from the expensive to the cheap bond. b) POLICY SWITCHING switches between two dissimilar bonds, to take advantage of anticipated changes in interest rates, the structure of the yield curve, bond credit ratings, and so on. c) INTERMARKET SPREAD SWITCHING moves between government and corporate bonds with different terms (eg, coupon rate, maturity date, credit rating) to obtain a more positive yield spread.

Question 32

What are the strategies used in passive bond management?

Answer 32

* CASH FLOW MATCHING simply purchases bonds whose redemption proceeds will meet a liability as they fall due. * IMMUNISATION (or duration matching), buying a portfolio of bonds with a duration (not maturity) equal to any liabilities. * LADDERING involves buying bonds with a range of different maturities, thus reducing sensitivity to interest rate risk. As each bond matures, funds become available for withdrawal, or can be reinvested in bonds with later maturities. * BULLET PORTFOLIOS invest in bonds with durations close to that of the liabilities; eg, an investor with a liability due in ten years could construct a bullet portfolio of nine- and 11-year duration bonds in equal proportions. * BARBELL PORTFOLIOS involve investing in a portfolio of both short- and long-dated bonds; eg, one- and 30-year bonds. * COMBINATION/HORIZON MATCHING is a hybrid strategy that involves matching early liabilities with cash flows, and later liabilities with immunisation strategies.

Question 33

What is it called when an ESG bond loses its ESG rating?

Answer 33

Falling from grace

Question 34

What are the maturities at issue for T-Bonds and T-Notes?

Answer 34

T Bonds >10 years T Notes 2-10 years

Question 35

What inflation measure do Index Linked Gilts follow?

Answer 35

RPI (RPI methodology to change in 2030)

Question 36

What time period of RPI to Index Linked Gilts pay?

Answer 36

* The rate of inflation used will always be the rate **3-months before the payment** is due, * So the base rate is also based on the rate 3-months before issue. * Older issues, prior to 2005, have an 8-month lag!

Question 37

Systematic Risks for Bonds? | GRIPE

Answer 37

* Gov finance * Returns from other investments * Inflation * Pressures Internationally * Economic Growth | GRIPE