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Flashcards in Debt Instruments 16% Deck (116)
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Credit Risk

-also known as business risk
-also known as default risk
-the issuer may become insolvent and forced into bankruptcy

1

Bond Ratings - S&P - uses a + or -

AAA
AA
A
BBB
-------------
BB
B
C
D - default

above the line, securities are investment grade and can be purchased by a bank, below, non-investment grade or junk bonds

2

Bond Ratings - Moody's - uses 1, 2, 3 with ratings

Aaa
Aa
A
Baa
---------
Ba
B
Caa
D

above the line, securities are investment grade and can be purchased by a bank, below, non-investment grade or junk bonds

3

Interest Rate Risk

-Longer the duration, the greater the risk
-lower interest rates carry a higher interest rate risk

4

Zero Coupon Bond or OID

-purchased at a steep discount and gains in value every year.
-the difference between what the investor pays for the bond and what is received at maturity is considered interest income.
-Original Issue Discounts

5

Inflation risk

-also known as purchasing power risk
-created by too many dollars chasing too few goods

6

Reinvestment Risk

-if rates drop, will have less income
-a zero coupon bond does not have reinvestment risk

7

Why purchase a callable bond

They have higher stated, or nominal, interest rates

8

Why would an issuer pay a higher interest rate by issuing a callable bond?

to have he privilege to refinance at lower future interest rates

9

What price are callable bonds called at

frequently above par, which is called the call premium.

10

Liquidity Risk

-The degree to which an asset can be quickly converted to cash
-the risk that an asset cannot be sold quickly
-selling quickly could result in a substantial loss

11

Marketability Risk

-risk of being unable to buy or sell a security, thus sustaining a loss
-similar to liquidity, except it is not concerned with the price, only the ability to buy or sell

12

Legislative Risk

-also know as "regulatory or political" risk
-changes in law will negatively impact the value of a security

13

Term Bonds

-also called "dollar bonds"
-all bonds are issued at once and mature at once
-priced in points as a percentage of par value, each point equals $10
-term bond quote of 98 = 98% of par value = $980
-pays interest only, at maturity pays par
-Basis = price to maturity

14

Serial

-quoted in basis points
-all bonds are issued at once.
-They mature in increments over several years,
-ex: $1,000,000 of bonds matures in $200,000 increments over 5 years.
-pays principal and interest
-basis = yield to maturity

15

What are the terms for the interest an issuer will pay until the bond matures?

-Stated Rate
-nominal yield
-coupon rate

16

Current Yield

= (annual dollar interest paid)/(current market price)

17

Yield to Maturity (YTM)

-Economic benefit that would be realized if a bond or other fixed income security was held until maturity date.
= (Annual Interest +/- Annualized Gain/Loss)/((Purchase Price + Redemption Price)/2)

18

Yield to Call (YTC)

-Evaluates the performance of a callable bond
-uses the call price instead of par value

19

Par Bond

The nominal yield, current yield, and yield to maturity are the same

20

Discount Bond

the highest yield is the yield to maturity, followed by the current yield, then the nominal yield is the lowest

21

Premium Bond

The highest yield is the nominal yield, followed by the current yield, with the yield to maturity being the lowest.

22

Discount and Premium Chart for Yields (includes calls)

Discount Bond
- Highest yield is Call (cannot quote call)
- Next highest is Maturity or Basis
- Third yield is Current
- Lowest yield is nominal

Premium Bond
- Highest yield is NOMINAL
- Next highest Yield is CURRENT
- Third yield is MATURITY or BASIS
- Lowest yield is CALL (most quote this)

23

Standardized Yield (SEC Yield)

-measure of the current net market yields on a mutual fund's investment portfolio.
-net investment income for the 30 day period ending on the last day of the previous month DIVIDED by the highest offering price on that last day

24

Accrued Interest

-Bond interest is paid in arrears
-an investor purchases a bond and holds it for six months before receiving the first semi annual interest payment
-when a bond is sold in between the interest payments, the buyers pays the sell for the accrued interest

25

Corporate, muni, and gov agency bonds calculation of interest

every month has 30 days
every year has 360 days
Regular way settlement is T+3

26

Gov notes and Bonds calculating accrued interest

-actual number of days in the month
-each year, the actual number of days
-regular way settlement is T+1 (or next biz day)

27

Corporate Bond payment dates of F and A 15

Pays February and April 15

28

Open and Closed end Bonds

-open - corporation can issue subsequent bonds at a later time
-Closed - specify maximum indebtedness the corp can issue

29

Bond Trust Indenture

-specifies if the secured bonds are open or closed
-contract between issuer and trustee, who acts on behalf of the bondholder
-open end bonds have equal claim or parity of title to the collateral with each new bond