Fixed Income Flashcards
In using matrix pricing to estimate the required yield spread on a new corporate bond issue, the benchmark rate used is:
the YTM on a government bond with similar time to maturity
A source of
- interim financing for long term projects, until permament financing is found
- funding for working capital and seasonal demand for cash
- Only available to large corporations with high credit ratings
- supported by credit enhancement
Commercial paper
Sinking fund:
Requires that the issuer retire a portion of the ____ through a series of principal payments over the life of the bond
Requires that the issuer retire a portion of the principal through a series of principal payments over the life of the bond
Similar to serial maturity bond structures
US company, issuing a bond in the US, in dollars
Is an example of:
Domestic bond
Japanese company, issuing a bond in the US, in dollars
Is an example of:
Foreign bond
Bond issued internationally, outside the jurisdiction of the country in whose currency the bond is denominated
Eurobonds
Japanese company, issuing a bond in the US, in Yen
- buy and sell orders are initiated from various locations and then matched through a communications network;
- most bonds are traded in this market
OTC/dealer market
Bonds settle how many days after the trade date?
- Corporate bonds: T + 2 or T + 3
- Government bonds: T+1
- unsecured obligations of the national government issuing the bonds;
- not backed by collateral, but by the taxing authority of the national government
sovereign bonds
Bonds with a floating rate of interest that resets periodically based on changes in the level of a reference rate, such as Libor.
Floating rate bonds
Which type of sovereign bond has the lowest interest rate risk for an investor?
Floaters
Because changes in the reference rate reflect changes in market interest rates, price changes of floaters are far less pronounced than those of fixed-rate bonds, such as coupon bonds and discount bonds.
Thus, investors holding floaters are less exposed to interest rate risk than investors holding fixed-rate discount or coupon bonds
Bonds issued by a government sponsored/owned issuer, that typically have higher yields
Quasi government bonds
Agency bonds are issued by:
quasi government
government sponsored/owned
Issued by federal agency: Government national mortgage association (Ginnie Mae)
Issued by government sponsored agencies: Federal national mortgage association (Fannie Mae) & federal home loan mortgage corporation (Freddie Mae)
A sinking fund arrangement is a way to reduce ____ risk, but increases _ risk:
Credit risk
* Sinking funds add an element of security and lowers default risk
* Due to the lower interest rates on the bonds, the company is usually seen as creditworthy, which can lead to positive credit ratings for its debt
* Sinking funds have higher reinvestment risk
the difference between the market value of the underlying collateral and the value of the loan
repo margin
supply & demand conditions of collateral
When the credit quality of the counterparty decreases, the repo margin will:
Increase
If the collateral is in short supply or if there is a high demand for it, repo margins are ?
lower
The market for loans and deposits between banks, for maturities up to one year
interbank money market
- The most recently issued sovereign securities, of a particular maturity
- Are the most active in the secondary market because they are highly liquid
on the run Treasury bonds of a particular maturity
benchmark issue for other bond yields
A form of short-term collateralized borrowing in which a bondholder sells a security and agrees to buy it back at a higher price:
Repurchase agreement
A source of short-term funding for a bondholder
Rate based on the actual rates of repurchase transactions and reported daily by the federal reserve
structured overnight financing rate (SOFR)
Unsecured short-term loans from one bank to another
interbank funds market
issuance of sovereign debt is usually issued in which market?
primary market, by auctions
Do fixed or floating rates have more price variability?
fixed, since the coupon is fixed, the price changes as interest rates change
floating prices are more fixed, because the coupons are adjusting to interest rates
An entire issue is registered with securities regulators but the bonds are sold to the public over a period of time as the issuer needs to raise funds
Shelf registration
Issuer can offer additional bonds to the general public without preparing a new and separate offering
shelf registration;
as a part of auctions in the primary market
The risk of future interest rates being less than the YTM at the time the bond is purchased:
reinvestment risk;
* the investor reinvests the coupons at the market interest rate and the risk is that reinvesting will earn less when putting the coupons into a new investment
* the potential that the investor will be unable to reinvest cash flows at a rate comparable to their current rate of return
* More problematic when the current coupons being reinvested are large
Convexity:
- Demonstrates how the duration of a bond changes as the:
- If a bond’s duration increases as yields increase, the bond is said to have:
- If a bond’s duration rises and yields fall, the bond is said to have:
- Demonstrates how the duration of a bond changes as the interest rate changes
- If a bond’s duration increases as yields increase, the bond is said to have negative convexity
- If a bond’s duration rises and yields fall, the bond is said to have positive convexity
Conevexity effect
When interest rates rise & fall by the same amount:
- Rise: bond price decrease by:
- Fall: bond price increases by:
- interest rates rise = price falls by less (overestimate)
- Interest rates fall= price increase by more
moreconvexity effect (underestimate)
Flat price of a bond=
Flat price (clean) = Full price (dirty) - Accrued interest
Bond dealers most often quote the:
flat (clean) price; to avoid misleading investors about the market price, since the full (dirty) price includes the accrued interest
Z-spread:
- Z-spread is the spread that is added to each:
- Cause the present value of the bond cash flows to equal:
- Z-spread is the spread that is added to each zero-coupon bond spot rate (treasury bond)
- Cause the present value of the bond cash flows to equal:the bond’s price
does not include value of embedded options
Nominal spread:
- The difference between _ & _ , with a similar maturity
- A nominal yield spread is the difference between a Treasury and non-Treasury security with the same maturity
Nominal Spread = Treasury YTM - Corporate bond YTM
- The spread is frequently used in pricing certain types of mortgage-backed securities
- It is the amount that, when added to the yield at one point on the Treasury yield curve represents the discount factor that will make a security’s cash flows equal to its current market price
If the I-spread increases, credit risk:
If the I-spread increases, the credit risk also increases
We can use LIBOR as an example. It shows the difference between a bond’s yield and a benchmark curve
Interpolated spreads (I-spreads) are:
- The difference between:
- The difference between a bond’s yield and the swap rates
We can use LIBOR as an example. It shows the difference between a bond’s yield and a benchmark curve
An obligation of the corporation that issues them, but their interest and principal payments are provided by a pool of assets that are legally recognized as bankruptcy remote:
Covered Bonds
Oftenly used in Europe
- Similar to ABS, but the underlying assets remain on the balance sheet of the issuer
- Thus, no SPE is created
Issued by a special purpose entity to which the underlying assets are sold:
Securitized bonds (i.e., asset-backed securities)
Bonds with multiple maturity dates are issued at the same time
Serial bond issue
Unsecured debt, in the United States is referred to as:
Debentures
Backed by a claim to specific assets of a corporation:
Secured Bonds
Reduces default risk, and thus lowering yield
- Overcollateralization
- Cash reserve fund
- Excess spread account: setting aside amounts to protect against losses
- Tranches
Internal Credit Enhancement methods
Built into the structure of a bond issue
- Surety bonds
- Bank gaurantees
- Letters of credit
External Credit Enhancement methods
90-day LIBOR plus 125 bps
Floating rate note
125 bps in constant (fixed)
For a reference rate note:
For a variable rate note: there is a spread above the reference rate, that fluctuates
A bond initially does not make periodic payments but instead accrues them over a pre-determined period and then pays a lump sum at the end of that period. The bond subsequently makes regular periodic payments until maturity:
Deferred-coupon bonds
Deferred coupon bonds carry coupons, but the initial coupon payments are deferred for some period. The coupon payments accrue, at a compound rate, over the deferral period and are paid as a lump sum at the end of that period. After the initial deferment period has passed, these bonds pay regular coupon interest for the rest of the life of the issue (i.e., until the maturity date)
Has a coupon rate that increases on one or more specified dates during the note’s life:
Step-up note
The Lender is the:
Bondholder
The Borrower is the:
Bond Issuer
What all is included in a bond indenture?
- Obligations of the issuing firm (positive covenants)
- Restrictions of the issuing firm (negative covenants)
- Source of funds for repayment
Not included: the identity of the lender (bondholder) since bonds can be traded throughout their lives
Clause that states that a bond will have the same priority of claims as the issuer’s other senior debt issues:
Pari Passu
Affirmative Covenant
Clause that states that if the issuer defaults on any other debt obligation, they will also be considered in default on this bond:
Cross-default
affirmative covenant
A corporation has borrowed $10 million. It will repay this by making payments of $1.3 million each year for 9 years and a payment of $8 million at the end of the 10th year. This type of bond is referred to as:
Partially amortizing bond
8M at year 10 is the balloon payment
If two banks fund a loan to a corporation, the loan is most accurately described as a:
Syndicated Loan
Loans funded by more than one bank
A bilateral loan involves:
One bank
Bilateral refers to the lender (Bank) and borrower (corporation)
Describe the bid-ask spread for liquid and illiquid issues, in the secondary market:
Narrow spread: highly liquid issues
Wider spread: less liquid issues
Secondary Market: OTC/Dealer Market
Credit quality & liquidity are reflected in:
Yield spreads
Reference rate for a floating rate note should match:
- Currency
- Frequency of coupon resets
90-day yen Libor for a yen-denominated note that resets quarterly.
Corporate issues that can be structured to meet the requirements of investors
Medium term notes
Does not imply anything about the maturity
Issuer agrees to pay the entire amount borrowed in one lump-sum payment at maturity:
Term maturity structure
- Structured securities combine:
- Designed to change the:
- Medium term notes & Derivatives
- Designed to change the risk profile of an underlying debt security, by combining a debt security with a derivative
Creates features designed by an investor
Interest rates used to discount a single cash flow to be received in the future
Spot rates
- YTM on a zero coupon bond
- Gives the yield broken out into components, instead of blended
All of the return from a zero-coupon bond comes from:
Price appreciation
The increase from purchase price to face value at maturity is interest income
The yield spread:
- Is difference of yields in two different bonds with:
- the same maturity
- different credit quality
Usually it is a comparison of a bond to a US treasury (benchmark)
In a CPI interest-indexed bond, how does a CPI increase affect:
- Coupon rate:
- The par value:
- Coupon rate is adjusted for inflation
- The par value remains unchanged
(CPI * PMT)
- “Max acceptable debt usage ratios”
- “Minimium acceptable interest coverage ratios”
- Limit on the level of share buybacks
examples of negative covenants
“What the issuer will do with the proceeds of a bond issue”
Example of affirmative covenants
Typically administrative in nature
The price sensitivity of a bond or portfolio to a change in the interest rate at one specific maturity on the yield curve.
Key rate duration
Used to estimate interest rate risk for non-parallel shifts in the yield curve
The option adjusted spread removes the option yield component out of the:
option yield is removed from the **Z-spread **
Convexity of callable bonds is:
Negative
An upward-sloping term structure of yield volatility most likely indicates greater volatility in:
A downward-sloping term structure of yield volatility most likely indicates greater volatility in long-term bond YTM, than in short-term bond yields to maturity.
