bonds and shit (only what is confusing) Flashcards
Yield to Maturity
Bond’s internal rate of return
The interest rate that makes the PV of a bond’s payments equal to its price; assumes that all bond coupons can be reinvested at the YTM
rate of return over the life of the bond if all coupons are reinvested atYTM
current yield
Bond’s annual coupon payment divided by the bond price
which is bigger between the YTM, current yield, and coupon rate for premium bonds
coupon rate > current yield > YTM
which is bigger between the YTM, current yield, and coupon rate for discount bonds
YTM > current yield > coupon rate
callable bond
can be called by the seller
Can be bought back by the seller at a specified price and date
Purchased by the issuer
if interest rates fall
which bond between a straight bond and a callable bond will be more expense? why?
a straight bond
The price of the callable bond is flat over a range of low interest rates because the risk of repurchase or call is high
When interest rates are high, the risk of call is negligible and the values of the straight and the callable bond converge
why is the yield to call more interesting to investors than the YTM?
because they believe the bond will be retired at CALL date
ex-ante yield
realized yield
future yield
we would need to forecast uncertain future reinvestment rate
Coupon will be invested at a rate we do not know
with longer horizons, is the cash flow or capital gains usually bigger?
cash flows
Sources of risk as IR change
Increase IR thenValue of Bond drops
Increase IR then Reinvestment rate of coupon increases
Reinvestment rate risk offsets price risk
when is bond selling at discount
coupon rate < IR
HPR
(P1 + C - P0) / P0
Zero Coupon Bonds
provide only one cash flow at the end of maturity
ex: Government of CanadaT-Bills
Stripped Coupon
zero coupon bonds with multiple periods per year
when are the profits of a bond taxed as normal income?
cash flow
when a bond that was sold at discount and naturally increases in price increases in price
