week 6 Flashcards
(40 cards)
1
Q
what are the advantages of bonds:
A
- receiving income through interest payment
- hold the bond to maturity and get all your principal back
- profit if you resell the bond at higher price
2
Q
what are the disadvanatages of bonds:
A
- bonds pay out lower returns than stocks
- companies can default on your bonds
- bond yields can fall
3
Q
what is the relationship between yields to maturity and price of coupon bonds?
A
- they have a negative relationship
- the increase in price of bonds => the decrease in yileds to maturity
4
Q
what is the relationship between interest rates and price of coupon bonds?
A
- inverse relationship - the more the bond price increases, the more the interest rate falls
5
Q
factors affecting bond prices? - primary capital market
A
- any bond which has a higher coupon payment will have a higher price
- any bond which has a higher par value (face value) will have a higher price
- any bond which has a higher years to maturity will have a higher price
BUT
- any bond which has a higher yield to maturity will have a lower price
6
Q
what is the primary capital market for bonds?
A
- new shares and bonds are offered to the public for the first time via na initial public offering (IPO)
7
Q
what is the secondary capital market for bonds?
A
- refers to the exchanges where stocks and bonds are traded
8
Q
factors affecting bond prices? - secondary capital (stocks) market
A
- credity rating or creditworthiness of the issuer of bonds
- liquidity of the secondary market for bonds
- time for the next payment of bonds
- the credit/default risk of the bond issuer is one of the most obvious risks
9
Q
what are additional risk factors for the price of bonds?
A
- interest rates
- possibility of a credit ratings downgrade
- inflation rates
10
Q
what is market risk?
A
risk of unexpected changes in prices or rates
11
Q
what is credit risk?
A
risk of default or reduction in value associated with unexpected chnages in the credit quality of issuers or counterparties
12
Q
what is default risk?
A
possibility that a counterparty in a financial contract will not fulfil a contractual commitment to meet her/his obligations stated in the contract
13
Q
what is a credit rating?
A
a credit rating is an evaluation of credit worthiness of a debtor, especially a business (company) or a government
- the evaluation is made by credit rating agencies
- these are expressed in alphabetical or numerical symbols
- a popular method of quantifying “probability og default” is through credit ratings
14
Q
what are credit rating agencies?
A
a company that assigns credit ratings, which rate a debtor’s ability to pay back debt by making timely interest payments and the likelihood of default
15
Q
who are the top credit rating agencies?
A
- the industry is dominated by three big agencies which control 95% of the rating business
- Moody’s Investor Services, Standard and Poor;s (S&P) and Fitch Group
16
Q
what is the role of the credit agencies ?
A
- they assess the credit risk of specific debt securities and the borrowing entities
- the rating are used in structured finance transactions such as asset-backed securities, mortgage-backed securities, collateralized debt obliagation
17
Q
what are the bond rating by sp and moody?
A
AAA - highest quality
AA - superior quality
A - satisfactory quality
BBB - adequate quality
BB - speculative quality
B - highly speculative quality
CCC, CC, C - bery highly speculative quality
D - in default
18
Q
what are the two risks the rating analysis focuses on?
A
- Business Risk
- Evaluation of strengths/weaknesses of the operations of the entity, including: market position, geographic diversification, sector strengths or weaknesses, market cyclicality, and competitive dynamics.
- Financial Risk:
Evaluation of the financial flexibility of the entity, including: total sales and profitability measures, margins, growth expectations, liquidity, funding diversity and financial forecasts.
19
Q
what is the relationship between credit ratings and macroeconomic fundamentals?
A
- ratings effectively summarise the information contained in macroeconomic indicators
- the ordering of risk is broadly consistent with macroeconomic fundamentals
20
Q
what are the soverign (government) credit ratings? - based on determinants and impact of sovereign credit ratings
A
- high per capita income: appears to be closely related to high ratings
- lower inflation and lower external debt - consistently related to higher ratings
- GDP growth, fiscal balance, external balance - lack a clear bivariate reltion to ratings
- per capita income, gdp growth, inflation, external debt, and the indicator variables for economic development and default history - anticipated signs and are statistically significant
- coefficients on both fiscal and external balances are statistically insignificant and of the unexpected sign
21
Q
what is a yield curve?
A
- shows the interest rate associated with different contract lenghts for a particular debt instrument (ex: t bill)
- summarizes the relationship between the term (time to maturity) of the debt and he interest rate (yield) associated with that term.
- the gradient of the yield curve gives an indication of the forthcoming interest rate chnages and economic movement
22
Q
what is the term structure and how is it used to forecast interest rates?
A
- interest rate forecasts are extremely important to managers of financial institutions
- the term structure of interest rates has indicated that the slope of the yield curve provides general information about the market’s prediction of the future path in interest rates
- term strcuture = pure-expectations hypothesis. The expectations hypothesis establishes a relationship between long-term and short-term interest rates
23
Q
what is the us treasure yield curve?
A
- On a yield curve, the fixed-income securities with different maturities must be considered of comparable credit quality.
- consists of bills, notes, bonds that are considered theoretically risk-free, is the most frequent cited yiled curve and is used as benchmark for comparing the value of riskier bonds
- US treasury risk-free is the minimum interest rate an investor should expect to receive
23
Q
how does the yield curve graph look like?
A
graph plotting the yield (interest rate) of similar fixed-income securities across different maturity dates
24
how to interpret the yield curve?
- the shape of the curve provides information about what investors believe will happen in the fixed income market in the future
- the us treasury yield curve can represent investors' collective sentiments about the future conditions of the us economy
- shorter-term yields tend to represent what investors believe will happen to central bank policies in the near future
25
what is a normal yield curve?
- it is upward sloping, depicting higher interest rates for longer held maturities
- normal - because investors normally demand higher compensation for the added risk of holding longer-term securities and because it is the most common shape of the yield curve
26
what is a steeper yield curve?
- if the curve steepens, this means that the spread between long-term and short-term interest rates widens
- yileds on long-term bonds are rising faster than yileds on short-term bonds, or short-term bond yileds are falling as long-term bond yileds are rising
- a steeper yield curve often occurs during periods of economic expansion (upward sloping)
- steeper yield curves generally signals positive economic sentiment
27
what is a flat yield curve?
- ilustrates very little difference between short-term and long-term interest rates
- flat yield curve => short rates = (or about equal) to long rates
- it might signal uncertainty in the market from the investor point of view. Investors are hesitant to commit to either long-term or short-term assets.
- may indicate a transition between a normal yield curve to inverted, or an inverted curve to normal
- can occur during a period when the central bank such as FED is maintaining a stable monetary polocy with gradual adjustment to interest rates
- investors have neutral or uncertain expectations about the future direction of the economy => they do not strongly anticipate either economic expansion or recession in the near future
28
what is an inverted yield curve?
- downward sloping and depicts securities with longer maturities yielding lower returns than securities with shorter maturities
- occurs when a short-term debt instruments have higher yields than long-term instruments of the same credit risk profile
- it is not solely determined by the CB's actions or expectations since it can be influenced by a complex interplay of various factors - market sentiments, economic indicators, global events
- can be influenced by investors' different risk tolerance levels, investment goals, strategies
29
what are the main determinants of the slope of the yiled curve?
- changes in monetary policy (conventional and unconventional monetary policy)
- expectations of inflation
30
why did the yiled curve invert briefly in 2019?
31
what are term spreads (yiled curve spreads) ?
- measures the difference in yileds between a long-term and short-term gov bonds
32
what happens when interest rates change to yield curves?
- they have a larger effect on prices of long-term bonds than on prices of short-term bonds
33
what does the inverted yield curve signal?
- might signal recession
- The shape of the U.S. Treasury yield curve can be read as an indicator of the health of the country’s economy.
34
how the stock market works? - IPO
- operates similarly to an auction house, where sellers and buyers negotiate prices and make trades
- companies plan to go public list with their shares on the stock market and investors purchase those shares, so companies grow their business
- it is known as an initial public offerinf (IPO)
35
common type of stock indices?
- exchange based: stocks traded on one exchange or a group of exchnages - NASDAQ
- industrial: stocks that belong to a specific industry sector - energy: S&P Global Energy Index
- regional: stocks from a particular region (Euro Stoxx)
- national: stocks from a specific country
- global: stocks from across the globe world index tracks companies
36
how is a stock market index price calculated?
- using a weighted average of the prices of all the stocks that make up this index
- the weightings are determined by factors such as stock price or market cap
37
main examples of stock market indices?
S&P 500, Dow Jones Industrial Average, Nasdaq Composite, Financial Times Stock Exchnage, Nikkei 225, Russel 2000
38
what is the S&P 500 Index ?
- created in 1957 by standard and poor's is a collection of 500 of the largest publicly traded companies in the US
- includes companies from a wide range of industry sectors.
- provides a snapshot of the U.S. stock market and is often used as a benchmark for the overall performance or “health” of the U.S. economy.
- when it was created the largest companies in the index were General Motors, General Electric, and ExxonMobil. Over the years, however, the index has become increasingly dominated by companies in the information technology sector
- Energy; Materials; Industrials; Consumer Discretionary; Consumer Staples; Health Care; Financials; Information Technology; Communication Services; Utilities; Real Estate
39
what are some possible issues when using the s&P 500?
- Smaller companies are not included at all in the index, even if they are outperforming larger companies in the market
- Companies with the largest market capitalizations have the greatest influence on the index’s performance
- Sector bias occurs when a particular sector dominates the index, meaning that sector’s performance has a disproportionate impact on the overall performance of the index.
- information technology sector is over-represented
in the index, then any gains or losses in that sector will affect the overall performance of the index more than other sectors
