BONDS

Question 1

Bond prices

Answer 1

the present value of the coupons and the face value discounted at the rate.

P0 = SUMM(Ct/(1+rate)^t) + FV/(1+rate)^T

Question 2

the interest rate y (Yield to maturity)

Answer 2

equates the bond price to the present value = yield to maturity

Question 3

current yield

Answer 3

C.Y = coupon/Po

Question 4

acrued interest

Answer 4

if bonds are bough in between coupon payments the seller is entitled to recieve a pro-rata part of the next coupon
the sale price = flat price + acrued interest

accruedinterest = annual coupon payment/2 X days since last coupon/days between coupons

Question 5

if P0 > FV

Answer 5

bond sells at a premium and y<c

Question 6

if P0 = FV

Answer 6

bond sells at par y=c

Question 7

P0 < FV

Answer 7

bond sells at a dicount y>c

Question 8

yield 2 maturity

Answer 8

measure of total retuen that the investor obtains when buying th ebond today at P0 and keeping it till maturity

Question 9

issues with YTM approximation

Answer 9

assumes investor will be able to reinvest each coupon recieved at rate y throughout bond life

Question 10

what does the upward sloping yield curve mean

Answer 10

yields on longer-term bonds are higher than the yields on shorter-term bonds of the same credit quality. In other words, as the maturity of the bond increases, the yield also increases. This is the most common shape of the yield curve.

Question 11

downward sloping yield curve meaning

Answer 11

A downward sloping yield curve, also known as an inverted yield curve, occurs when the yields on longer-term bonds are lower than the yields on shorter-term bonds of the same credit quality. In this case, as the maturity of the bond increases, the yield decreases. An inverted yield curve is less common than an upward sloping yield curve and can be a sign of potential economic downturn.

Question 12

forwrad rates

Answer 12

market’s expecttaion of spot rates that will prevail in future

Question 13

MARKET EXPECTATIONS HYPOTHESIS

Answer 13

1. long run rates are a geometric average of current and future short rates
2. forward rate is an unbiased estimate of future short rates
3. BONDS OF DIFFERENT MATURITIES ARE TREATED AS PERFECT SUBSTITUTES
4. risk - neutral investors
5. no transaction costs.
6. no coupon payments, no defaults.

The fact that the term structure is upward sloping most of the time implies that the forward rate seems to overestimate the expected spot rate.

Question 14

LIQUIDITY PREFERENCE THEORY

Answer 14

investors have short horizons and are risk averse

lenders demand a liquidity premium to hold long-term bonds

long term borrowers willing to compensate and gain by locking in a rate.

Question 15

SEGMENTED MARKETS THEORY

Answer 15

1. bonds of different maturities are in fact distinct and unconnected markets
2. each of these markets finds its equilibrium seperately
3. some investors may face binding limitations in what maturities to invest in.

Question 16

interpreting the term structure

Answer 16

expectations of increases in rates can result in a rising yield curve but the rising curve need not imply expectations of higher future rates

very steep yield curve swarn of impending rate increase

falling yield curve = recession

Question 17

sensitivity to interest rate changes

Answer 17

long maturity bonds more sensitive

slope = average maturity

curvature = depends on cash flow distribution

Question 18

duration

Answer 18

the negative of the elasticity of the price to 1 + the yield

VOLATILITY = DURATION/ (1+Y)

Question 19

steepeners

Answer 19

gain from widening spread between short and long term YTM - combine a long short dated bond position with a short long-dated bond position.

Question 20

flatteners

Answer 20

gain from shrinking spread (flattening curve)
sell short term bonds and purchase long term bonds

Question 21

Convexity

Answer 21

duration gives an approximation of the change in bond price given the change in yield, the more curvey the yield price relationsjip, the worse the approximation - covexity accounts for this

Question 22

percentage changes in the value bond

Answer 22

can be found using duration and convexity

Question 23

duration and DV01

Answer 23

duration is the weighted sum of component durations