Bonds

Question 1

Are bonds quoted at bid or offer?

Answer 1

actually mid market

Question 2

what is the indexation lag?

Answer 2

IL bonds are calculated 3 months before redemption

Question 3

How do IL bonds work?

Answer 3

Final coupon and capital are uplifted by RPI

Question 4

Give one advantage of using strips

Answer 4

each with their own unique
redemption date, can be used to coincide with specific future liabilities

Question 5

what is a sinking fund requirement?

Answer 5

Call bond - issuer to redeem a specified amount at regular intervals

Question 6

How are Eurobonds issued?

Answer 6

Bearer form - payable to person holding it

Question 7

What is a negative pledge in relation to eurobonds?

Answer 7

prevent subsequent bonds from being issued with
greater security.

Question 8

Give 2 advantages of foreign bonds

Answer 8

Foreign exposure without ER risk - investor

Take advantage of interest rate differentials - issuer

Question 9

How do non competitive bids for bonds work?

Answer 9

Up to £500k - average of accepted prices

Question 10

How do corporate bids work?

Answer 10

Indicative bids made then priced accordingly

Question 11

Why do bonds trade above/below par?

Answer 11

If the coupon is below
current interest rates, the bond’s price will be below par - vice versa

Question 12

3 reasons for normal yield curve

Answer 12

Liquidity

Inflation

Market segmentation

Question 13

Reasons for inverted yield curve

Answer 13

IR rates to fall

Question 14

5 risks of bonds

Answer 14

Credit
Interest rate
Inflation
Liquidity
Exchange rate

Question 15

2 additional Corporate bond risk

Answer 15

Early redemption (call)

Seniority

Question 16

What are the last investment grade ratings

Answer 16

BAA

BBB x 2

Question 17

What are the most volatile bonds?

Answer 17

long and low

Question 18

Modified duration definition and calc

Answer 18

Bonds price sensitivity to IR changes

1+GRY

Question 19

2 features of cum dividend

Answer 19

comes with 6 months interest

Buyer compensates by paying price + Interest

Question 20

3 Features of ex dividend

Answer 20

Interest paid to who owns 7 days before interest date

Bond bought after that that date but before interest date then it goes to seller

Amount deducted from clean price

Question 21

Describe repo process

Answer 21

Sell Gilt and agree to buy back at set price

Difference is interest cost of loan

Gilt is security on default

Question 22

What is a Debenture

Answer 22

Secured corporate bond (either fixed or floating charge)

Question 23

Why is a floating charge higher risk?

Answer 23

Lower priority (can also be sold, fixed can’t)

Question 24

Macaulay duration line by line:

Answer 24

Present value = cash flow discounted by Interest Rate squared by time

Sum all - this is bond price

Multiply by time and sum all.

Divide this by price

Question 25

What does the MD actually show and how might it be used

Answer 25

Average number of years until cash flows = price paid Immunization = Match asset and liability duration so IR changes are irrelevant