Fin 4319-Record B8 Flashcards Preview

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Flashcards in Fin 4319-Record B8 Deck (29):

When will a callable bond be called away?

how far the interest rate is below the coupon rate of the bond


What is out of the money?

there is a low probability of the callable bond being called.


What is deep out of the money?

there is a very low probability of the callable bond being called.


Who has the option to call a callable bond?

The issuer has the option to call so it's not the investor. The issuer pays back the money earlier, and you the investor gets the money back earlier. It's the bad for the investor because interest rates have fallen, and may have have reinvestment risk.


in general will a callable bond price be traded at a lower price or higher?

lower price


callable bond suffers from negative convexity



discuss behavior credit spreads in the business cycle

if you thought cycle is going to strengthen or weaken, how would you alter the duration of your portfolio or the credit risk of your portfolio (default free treasuries, or junk bonds).


what are Moody's investment grade bonds?

baa and above are investment grade


what are Moody's junk bonds?

below baa are junk bonds


what are junk bond mutual funds called?

high yield bond fund


why do mutual funds create high yield bond funds?

some financial institutions are required by law to only own investment grade bonds so they could be mispriced. the mutual fund companies package the junk bonds together to sell them to investors for high yield.


For a company to be allowed to issue a bond, the company had to be investment grade quality, so where did Junk Bonds come from?

Investment grade companies were downgraded, also referred as fallen angels.


What are the differences between new junk and old junk bonds?

New junk bonds have a lot of loan workout provisions written in the bond indenture (contract between bond purchaser and bond issuer. Everyone knows there's a high risk of default so they create provisions in case they miss coupon payment.


What are PIK (payment in kind) provisions?

If the company has a bad quarter they will pay the junk bond investor with securities. This means you will automatically extend a loan to them for missing a coupon payment. If the company missed several coupons that would trigger a lawsuit.


what are loan workout provisions?

they are provisions written in new junk bonds that states when you may receive securities for missed payments instead of cash


what are the differences in yields at each run of bond rating?

the higher the rating, the lower the yield, and the lower the rating the higher the yield.


for the different bond ratings, are they a measure of absolute or relative default risk?

relative risk


when you go into a recession, what happens to the default risk at every level of rating?

default risk increases during a downturn in the economy. Companies don't usually go bankrupt in a strong economy.


what information is provided by bond ratings?

Bond ratings are very slow to change so the rating may not reflect the current price. The bond market price is a faster measure of bond investment or junk status than the rating by the credit ratings companies. The bond issuer pays the rating agency to do the ratings.


how do credit spreads move over the business cycle?

during recession the spread should widen. default risk goes up during recession. during recession people are less willing to take risk, maybe people will lose their jobs. rates fall during recession


what kind of economic indicator are interest rates?

they are a lagging indicator


how do tbills interest rates economic activity?

they are more volatile.. they rise faster and fall faster


in a expansion the spread is tightened

rates on treasuries rise or fall faster than high grade corporates


in a recession what yields do you get in junk bonds and treasuries

junk bond yields are highest and treasuries lowest. junk bonds are counter cyclicle


in an expansion what yields do you get in junk bonds and treasuries?

junk bonds yields are lower and treasuries are higher


What if you expect the economy to weaken unexpectedly?

You want to lengthen the duration of your portfolio.


How do you make money when you expect the economy to weaken unexpectedly?

Buy treasuries,
Don't buy junk bonds.
You want non-callable bonds.
Increase duration.
Increase credit quality


How do you make money when you expect the economy to strengthen unexpectedly?

Shorten duration by buying high grade corporate bonds

Decrease credit quality by Buying junk bonds


#review 7, describe the relationship between duration and bond price sensitively

direct relationship, duration is the price of the bond