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CFA > Fixed Income > Flashcards

Fixed Income Flashcards

Learn about fixed income securities, markets, valuation, asset-based securities, fixed income risk and return, and credit analysis.

1
Q

Define:

Add-on rates

A

Method of calculating interest rate, in terms of the amount that will be added to the principal in order to arrive at a future value.

Used for CDs, repos (bond yield basis).

As opposed to a discount rate

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2
Q

Define:

Amortizing bond

A

Bond with sceduled payments which pay interest as well as paying down the principal over the life of the bond.

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3
Q

Define:

Asset-backed securities

ABS

A

A type of bond which is backed by a collection of claims on assets (car loans, credit card receivables, etc.) and the cashflows from those assets. An ABS is issued by a special purpose entity (SPE) which owns the underlying assets and is a seperate legal entity unto itself.

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4
Q

Define:

Auction

A

A type of bond issuing mechanism often used for sovereign bonds that involves bidding.

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5
Q

Define:

Balloon payment

A

Large payment at maturity to retire a bond’s outstanding principal.

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6
Q

Define:

Bullet Bond

A

Bond where principal is repaid entirely at maturity.

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7
Q

Define:

Basis point

aka bp or “bips”

A

One basis point equals one-hundredth of a percentage point

.01% or .0001

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8
Q

Define:

Bearer bonds

A

Bonds for which ownership is not recorded; ownership is determined by who actually holds (bears) the bond.

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9
Q

Define:

Benchmark issue

A

The latest sovereign bond issue for a given maturity. It serves as a benchmark against which to compare bonds with similar features.

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10
Q

Define:

Benchmark rate

A

The yield-to-maturity on a government bond having a similar time-to-maturity.

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11
Q

Define:

Benchmark spread

A

The yield spread over a benchmark

Typically measured in bps

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12
Q

Define:

Best effort offering

A

When an investment bank, acting as agent for the issuer, promises to use its best efforts to sell the offering but does not guarantee that a specific amount will be sold.

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13
Q

Define:

Bond

A

Contractual agreement between the issuer and the lender (holder of the bond).

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14
Q

Define:

Bond equivalent yield

A

Method of calculating yield which annualizes the yield using the ratio of 365:number of days to maturity.

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15
Q

Define:

Book building

A

When Investment bankers develop a list (“build a book”) of parties that have indicated interest in buying part of an offering.

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16
Q

Define:

Broker

A

An agent who matches buyers and sellers and helps to facilitate transactions/execute trades on behalf of a client in exchange for a commission.

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17
Q

Define:

Broker–dealer

A

A financial intermediary who fulfills different roles depending on the type of trade. They may act as a dealer (fulfilling the role of the principal) or as a broker (fulfilling the fole of agent).

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18
Q

Define:

Callable bond

A

A bond containing an embedded call option. This gives the issuer the right to buy the bond back at specified prices on pre-determined dates.

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19
Q

Define:

Capital-indexed bonds

A

Type of index-linked bond. The coupon rate is fixed but it gets applied to a principal amount that increases in line with increases in the index during the bond’s life. Therefore the coupon amount changes along with the principal.

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20
Q

Define:

Capital market securities

A

Securities with maturities at issuance longer than one year.

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21
Q

Define:

Cash flow yield

A

The IRR on a series of cash flows.

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22
Q

Define:

Central bank funds market

Fed Funds Market in the US

A

The market in which deposit-taking banks which have an excess reserve with the central bank can loan money to banks that need funds.

used for maturities ranging from overnight to a year.

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23
Q

Define:

Central bank funds rates

A

Interest rates applied to money lent within the central bank funds market (Fed Funds Market in the US).

maturities from overnight to a year

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24
Q

Define:

Certificate of deposit

CD

A

Investment instrument which enables one to invest a specific amount of money for a fixed period at a predetermined interest rate. It is issued in small or large denominations, and can be negotiable or non-negotiable.

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25
Q

Define:

Four C’s

A

Character, Capacity, Collateral, Covenants

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26
Q

Define:

Character

A

Quality of a debt issuer’s management. Extent to which one can trust that the issuer’s management will do what is expected and what is right.

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27
Q

Define:

Collateral trust bonds

A

Bonds secured by securities such as common shares, other bonds, or other financial assets.

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28
Q

Define:

Collateralized debt obligation

CDO

A

A security backed by a diversified pool of one or more debt obligations.

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29
Q

Define:

Collateralized mortgage obligation

CMO

A

Essentially a mortgage backed security, but with tranching to try and reduce prepayment risk.

This differs from a passthrough MBS

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30
Q

Define:

Commercial paper

A

Short term (< 1 year) promissory notes from creditworthy corporations, typically issued to fund working capital or provide bridge financing.

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31
Q

Define:

Constant-yield price trajectory

A

Illustrates the change in the price of a bond over time assuming no change in YTM. The trajectory shows the “pull to par” effect on the price of a bond trading at a premium or a discount.

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32
Q

Define:

Contingent claims

A

Derivatives in which the payoffs occur if a specific event occurs.

“contingent upon a particular outcome”

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33
Q

Define:

Contingent convertible bonds (CoCos)

A

Bonds that automatically convert into equity if a specific event or circumstance occurs.

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34
Q

Define:

Contraction risk

A

The risk that, when interest rates decline, the security will contract (be shorter than anticipated) due to borrowers refinancing at lower rates.

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35
Q

Define:

Conversion price

A

The price per share at which the bond can be converted into shares.

For a convertible bond

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36
Q

Define:

Conversion ratio

A

The number of common shares that each bond can be converted into.

For a convertible bond

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37
Q

Define:

Conversion value

A

The current share price multiplied by the conversion ratio.

For a convertible bond

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38
Q

Define:

Convertible bond

A

Bond which allows the bondholder to exchange the bond for a specified number of common shares.

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39
Q

Define:

Convexity adjustment

A

Convexity adjusts the percentage price change estimate based on modified duration to better approximate the true relationship between a bond’s price and its yield-to-maturity which is convex in nature.

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40
Q

Define:

Covenants

A

The terms and conditions of lending agreements; they specify what the issuer must do (affirmative covenant) and must not do (negative covenant).

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41
Q

Define:

Covered bond

A

Debt obligation secured by a segregated pool of assets (cover pool). The issuer must maintain the value of the cover pool.

In default, holders have claim against issuer and pool.

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42
Q

Define:

Credit

A

Accounting: A credit records increases liabilities, owners’ equity, and revenue accounts or decreases in asset accounts.
Borrowing: the willingness/ability of the borrower to make promised payments.

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43
Q

Define:

Credit analysis

A

Evaluation of the creditworthiness (and credit risk) of a borrower or counterparty.

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44
Q

Define:

Credit curve

A

A curve showing the relationship between time to maturity and yield spread for an issuer with comparable bonds of various maturities outstanding.

Typically upward sloping

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45
Q

Define:

Credit default swap (CDS)

A

A type of credit derivative in which one party (the buyer), seeking credit protection, makes a series of scheduled payments to the other party (the seller). The seller only has to pay if a credit event occurs.

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46
Q

Define:

Credit enhancements

A

Provisions used to reduce the credit risk of a bond issue.

ex. overcollateralization

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47
Q

Define:

Credit-linked coupon bond

A

Bond with a coupon which changes when the bond’s credit rating changes.

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48
Q

Define:

Credit-linked note

CLN

A

Fixed-income security, typically a bond, whose performance, repayment of principal, and interest are linked to the credit quality or default risk of one or more underlying reference entities.

Entity could be a bank, government, etc.

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49
Q

Define:

Credit risk

A

The risk of loss due to counterparty’s failure to make a promised payment.

aka default risk

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50
Q

Define:

Collateral

A

Assets or guarantees used to secure a debt obligation.

(provides assurance to the creditor)

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51
Q

Define:

Credit tranching

A

A structure used to distribute the credit risk into different levels. Bond classes created to allow investors a choice in the amount of credit risk to bear.

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52
Q

Define:

Credit-worthiness

A

The perceived ability of the borrower to pay what is owed on time.

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53
Q

Define:

Cross-default provisions

A

Provisions whereby a default event on one bond triggers default on all outstanding debt; The same default probability for all issuances.

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54
Q

Define:

Currency option bonds

A

Bonds that give the bondholder the right to choose which currency to receive interest payments and principal repayments in.

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55
Q

Define:

Current yield

A

Coupon payments received over the year divided by the flat price

aka income yield

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56
Q

Define:

Currency swap

A

A swap in which each party makes interest payments to the other in different currencies.

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57
Q

Define:

Duration

A

The sensitivity of the bond price to a changes in interest rates.

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58
Q

Define:

Debentures

A

A type of bond which are typically unsecured (although can be secured), and typically have a longer term.

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59
Q

Define:

Default probability

A

The probability that a borrower defaults (fails to meet its obligations) according to the terms of the debt security.

aka default risk

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60
Q

Define:

Default risk premium

A

An extra return that compensates investors for the possibility that the borrower will default.

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61
Q

Define:

Default risk

A

The risk that a borrower defaults or fails to meet its obligation to pay, according to the terms of the debt security.

aka credit risk

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62
Q

Define:

Deferred coupon bond

A

Bond that pays no coupons for its first few years but then pays a higher coupon than it otherwise normally would for the remainder of its life.

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63
Q

Define:

Downgrade risk

A

The risk that a bond issuer’s creditworthiness deteriorates leading to a credit rating downgrade.

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64
Q

Define:

Dual-currency bonds

A

Bonds that make coupon payments in one currency and pay the par value at maturity in another currency.

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65
Q

Define:

Duration gap

A

A bond’s Macaulay duration minus the investment horizon.

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66
Q

Define:

Effective convexity

A

Measures the secondary effect of a change in a benchmark yield curve on a bond’s price.

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67
Q

Define:

Effective duration

A

The sensitivity of a bond’s price to a change in a benchmark yield curve.

68
Q

Define:

Equipment trust certificates

A

Bonds secured by equipment or physical assets.

69
Q

Define:

Eurobonds

A

Bond issued internationally, outside the jurisdiction of the country in whose currency the bond is denominated.

70
Q

Define:

Expected loss

A

Default probability x Loss severity given default

71
Q

Define:

Extension risk

A

The risk that, when interest rates rise, fewer prepayments will occur and, as a result, the security becomes longer in maturity than anticipated.

72
Q

Define:

Face value

A

The promised payment at a bond’s maturity, separate from the coupon payment.

73
Q

Define:

First lien debt

A

Debt secured by a pledge of certain assets

Assets = buildings, equipment, lease, brand, patent, etc.

Holds highest priority of claim on the asset.

74
Q

Define:

First mortgage debt

A

Debt secured by a pledge of a specific property.

Claim is on real estate.

75
Q

Define:

Flat price

A

A bond’s full price minus accrued interest

aka clean price

76
Q

Define:

Floating-rate notes

A

A note with interest payments that are not fixed, but vary depending on level of the reference interest rate.

77
Q

Define:

Full price

A

The price of a bond including accrued interest

aka “dirty price”

78
Q

Define:

G-spread

A

The yield spread over a government bond (actual or interpolated).

in bps

79
Q

Define:

Government equivalent yield

A

A yield that restates a yield-to-maturity from 30/360 day-count to actual/actual.

80
Q

Define:

I-spread

aka interpolated spread

A

The yield spread of a bond over the standard swap rate of the same tenor.

81
Q

Define:

Indenture

A

Legal contract describing a bond, the obligations of the issuer, and the rights of the bondholders.

aka trust deed

82
Q

Define:

Index-linked bond

A

Bond with coupon payments and/or principal repayment linked to an index.

83
Q

Define:

Inflation-linked bond

A

Index-linked bond with coupon payments and/or the principal repayment linked to an index of consumer prices.

84
Q

Define:

Inflation premium

A

Additional return which compensates investors for expected inflation.

85
Q

Define:

Key rate duration

A

Price sensitivity to shifts in key interest rates along the yield curve.

for a fixed-income instrument or portfolio

86
Q

Define:

Lead underwriter

A

The lead investment bank in a syndicate involved in a securities underwriting.

87
Q

Define:

Lender of last resort

A

An entity willing to lend money when no other entity is.

88
Q

Define:

Lessee

A

The entity entering a lease in order to obtain the right to use an asset which they do not own.

89
Q

Define:

Letter of credit

A

When a financial institution provides the corporation with a credit line to compensate for any cash flow shortfalls from the assets backing the issuance.

means of external credit enhancement

90
Q

Define:

Lessor

A

In a lease agreement, the owner of the asset. Grants the other party (lessee) the right to use the asset.

91
Q

Define:

Liquidity

A

When an asset can be bought or sold quickly/easily at a price close to fair market value. Also used to mean the ability to meet short-term obligations.

92
Q

Define:

Liquidity premium

A

Additional return to compensate investors for the risk of loss due to a lack of liquidity (inability to convert to cash quickly).

93
Q

Define:

London interbank offered rate (Libor)

A

Term for multiple rates that a select set of banks believe they could borrow unsecured funds from other banks in the London interbank market for different currencies and different terms, ranging from overnight to one year.

Was once a key market reference rate, but transition away from reliance on LIBOR has begun.

94
Q

Define:

Loss severity

A

Portion of a bond’s value (including unpaid interest) an investor will lose if a default occurs.

Factor in calculating Loss Severity (due to default)

95
Q

Define:

Macaulay duration

A

Macaulay duration is a weighted average of the time to receipt of all of the bond’s cashflows.

96
Q

Define:

Matrix pricing

A

Process of estimating the market discount rate and price of a bond, based on the flat prices of more frequently traded comparable bonds.

97
Q

Define:

Maturity premium

A

Additional return to compensate investors for the increased sensitivity of debt to a change in interest rates for longer maturities.

98
Q

Define:

Medium-term note

A

A corporate bond offered continuously to investors by an agent of the issuer.

Provides a funding gap between commercial paper and long term bonds.

99
Q

Define:

Mezzanine financing

A

Debt/preferred shares connected to common equity due to a feature like attached warrants or conversion options. Subordinate to both senior and high-yield debt.

Name refers to location on the balance sheet (in the capital structure)

100
Q

Define:

Modified duration

A

Percentage price change of a bond due to a change in its yield-to-maturity.

101
Q

Define:

Money duration

A

Price change given a change in its yield-to-maturity, expressed in the currency in which the bond is denominated.

102
Q

Define:

Money market yield

A

A yield on a 360-day basis (comparable to the quoted yield on an interest-bearing money market instrument).

annualized holding period yield, assuming a 360-day year

103
Q

Define:

Money market securities

A

Fixed-income securities with original maturities of one year or less.

104
Q

Define:

Mortgage-backed securities

MBS

A

Bonds which represent claims to the cash flows from pools of mortgage loans.

105
Q

Define:

Mortgage pass-through security

A

A type of mortgage-backed security (MBS) that represents an undivided ownership interest in a pool of residential mortgage loans.

106
Q

Define:

Municipal bonds

Muni Bonds

A

A non-sovereign bond issued by a state or local government in the United States. Often provides income tax exemptions.

107
Q

Define:

Non-recourse loan

A

Loan in which the lender does not have additional recourse against the borrower, and can only use the property to recover the outstanding mortgage balance in the event of a default.

108
Q

Define:

Non-sovereign government bonds

A

A bond issued by a government below the national level.

province, region, state, city

109
Q

Define:

Notching

A

Ratings adjustment methodology where specific issues from the same borrower may be assigned different credit ratings.

110
Q

Define:

Off-the-run

A

Government bonds which are not the most recently issued or the most actively traded.

111
Q

Define:

On-the-run

A

Most recently issued/most actively traded sovereign bonds.

112
Q

Define:

Option-adjusted price

A

Flat price of the bond + value of embedded option.

113
Q

Define:

Option-adjusted yield

very closely related to OAS

A

The expected yield, or required market discount rate, which adequately adjusts the price of the bond for the value of the embedded option.

114
Q

Define:

Option-adjusted spread

OAS

A

OAS = Z-spread – Option value

in bps

115
Q

Define:

Overcollateralization

A

Internal credit enhancement method where firm posts more collateral than necessary in order to obtain or secure financing.

116
Q

Define:

Par curve

A

A yield curve that represents the YTMs of fixed-income securities of different terms to maturity which equates their prices to their face values (par value).

117
Q

Define:

Parallel shift

A

When all rates change by the same amount in the same direction.

118
Q

Define:

Par value

A

The principal amout for a bond.

119
Q

Define:

Pari passu

A

On equal footing

120
Q

Define:

Periodicity

A

The number of periods in the year

often matches frequency of coupon payments

121
Q

Define:

Plain vanilla bond

A

Bond that makes periodic, fixed coupon payments and a lump-sum payment of principal at maturity.

aka conventional bond

122
Q

Define:

Premium

A

For bonds, refers to the amount a bond is priced above its face (par) value.

123
Q

Define:

Prepayment risk

A

Uncertainty regarding the timing of cash flows due to the borrowers’ ability to alter payments (prepay or accelerate payments), usually to take advantage of interest rate movements.

124
Q

Define:

Price value of a basis point

PVBP

A

A version of money duration, it is an estimate of the change in the full price of a bond per a 1 basis point change in yield.

-Money duration x .0001

125
Q

Define:

Priority of claims

A

The rank of claims against cashflows/assets of issuer in event of default or bankruptcy.

126
Q

Define:

Putable bonds

A

When the bondholder has the right to sell the bond back to the issuer at a predetermined price on specified dates.

127
Q

Define:

Quasi-government bonds

A

A bond issued by an entity owned or sponsored by a national government.

aka agency bond

128
Q

Define:

Registered bonds

A

Bonds for which ownership is recorded (name or serial number).

as opposed to a bearer bond

129
Q

Define:

Repo margin

A

The difference between market value of the security posted as collateral and the value of the loan. (Value of the loan would be less than the value of the security).

This additional amount provides a buffer in case the market value of the security declines.

130
Q

Define:

Repurchase agreement

REPO

A

A collateralized loan in which a party sells a security with a simultaneous agreement to buy the same security back at an agreed-on price and future date. This party is borrowing money from the other party, and the security sold and repurchased acts as collateral.

131
Q

Define:

Repo rate

A

The interest rate on a repurchase agreement, to compensate the lender.

Repurchasing the asset at a higher price to include the interest on loan

132
Q

Define:

Required margin

A

The yield spread on the reference rate which prices a floating rate note at par on the rate reset date.

133
Q

Define:

Reverse repo

A

A repurchase agreement viewed from the perspective of the lender.

134
Q

Define:

Seasoned offering

A

When an issuer sells additional units of a previously issued security.

135
Q

Define:

Secured bond/debt

A

Debt instruments secured by assets or financial guarantees (ensuring debt repayment in case of default).

136
Q

Define:

Securitization

A

Involves moving assets into a seperate legal entity (SPE), which then uses the assets to secure a bond issuance.

137
Q

Define:

Securitized assets

A

Assets used to create asset-backed securities.

138
Q

Define:

Shelf registration

A

Type of public offering in which the issuer files a single, all-encompassing offering which covers a series of bond issuances.

139
Q

Define:

Sinking fund arrangement

A

Provision that requires the issuer to retire a portion of the principal outstanding each year.

Done to reduce credit risk

140
Q

Define:

Special purpose entity

SPE

aka special purpose vehicle (SPV)

A

Entity created to carry out a specified purpose, such as leasing or securitizing assets.

can be a corporation, partnership, llp, trust

141
Q

Define:

Spot curve

A

A sequence of YTMs on zero-coupon bonds of different terms to maturity.

142
Q

Define:

Spot rates

A

The discount rates, or yields-to-maturity on zero-coupon bonds maturing at the date of each cash flow.

143
Q

Define:

Spread risk

A

Risk that price will change on credit-risky bonds due to changes in the yield spread. Based upon the market pricing of credit migration risk and market liquidity risk.

144
Q

Define:

Step-up coupon bond

A

Bond for which the coupon increases by a specified amount at specified dates.

Coupons can be fixed or floating.

145
Q

Define:

Street convention

A

The IRR on cash flows assuming payments are made on the scheduled dates, even when it falls on a weekend or holiday.

146
Q

Define:

Structural subordination

A

When the debt of operating subsidiaries is serviced by their cash flow and assets, before funds can be passed on to the holding company.

Creates subordination in terms of claims, in a structural sense.

147
Q

Define:

Subordination

A

Method of internal credit enhancement when more than one bond tranche is created, with order of claim depending on the tranche.

aka credit tranching

148
Q

Define:

Structured financial instruments

A

Financial instruments where underlying risk is repackaged. This includes asset-backed securities, collateralized debt obligations, and others.

149
Q

Define:

Surety bond

A

Method of external credit enhancement- an insurance company guarantees to reimburse bondholders for losses incurred in case of default.

With a MAX limit.

150
Q

Define:

Syndicated offering

A

Bond issuance underwritten by a group of investment banks.

151
Q

Define:

Tenor

A

Time-to-maturity for a bond or derivative contract.

aka term to maturity

152
Q

Define:

Unsecured debt

A

When the debtholder only has a general claim on the assets and cash flow of the issuer.

Not secured by a specific asset or other collateral.

153
Q

Define:

Variable-rate note

A

Similar to a floating-rate note, in which the rate is determined by a market reference rate + a fixed spread, except that with a variable rate note the spread is variable as well.

154
Q

Define:

Yield

A

Return.
In this instance return on a debt security if held to maturity.

155
Q

Define:

Yield to maturity

A

Annual return an investor earns on a bond if bought today and held until maturity.
Can view as the discount rate which equates the PV (cash flows until maturity) with the bond’s price.

156
Q

Define:

Yield duration

A

The sensitivity of Price with changes in the bond’s own yield-to-maturity.

157
Q

Define:

Yield-to-worst

YTW

A

The lowest yield an investor can expect to receive from a fixed-income security, assuming the worst possible outcome in terms of the bond’s call provisions, prepayment, or other features that may affect its yield. Can view it as the lowest between yields-to-call and the yield-to-maturity.

kind of a worst case scenario

Very relevant for bonds with embedded options.

158
Q

Define:

Zero volatility spread

Z-spread

A

Constant yield spread over a government (or interest rate swap) spot curve.

159
Q

Define:

Zero-coupon bonds

aka pure discount bonds

A

Bonds which do not pay interest but instead are issued at a discount to par and then redeemed at par. (The return is purely in the appreciation that occurs at price moves from discount up to par).

160
Q

Define:

Cross-default

A

When borrower is considered in default if they default on another debt obligation.

161
Q

Define:

Empirical duration

A

Using historical prices and statistics to estimate duration.

162
Q

Define:

Hard bullet covered bonds

A

Covered bond with payments which are accelerated in the event of a failure to pay according to original schedule.

163
Q

Define:

Market reference rate (MRR)

A

Underlying interest rate which provides a reference point for pricing and valuing financial instruments (ex. interest rate swaps, FRNs).

LIBOR has been replaced by daily average market observed rates (SOFR, the euro short term rate, Sterling Overnight Index Average (SONIA)).

164
Q

Define:

Soft bullet covered bond

A

Covered bonds where the default and acceleration of payments may be delayed until new final maturity date is reached.

165
Q

Define:

Structured notes

A

Securities which combine debt instruments and embedded derivatives to achieve a particular objective.

166
Q

Define:

Unitranche debt

A

A blended structure which combines different tranches (or secured & unsecured debt) into a single loan with a single interest rate.

CFA (10 decks)

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