3. Bonds

Question 0

Name 4 types of bond

Answer 0

Government bonds/securities
Corporate bonds
Eurobonds
Mortgage & asset-backed securities

Question 1

What is a bond?

Answer 1

A debt security - a security that represents a loan made to a third party.

Question 2

What is the main risk associated with bonds?

Answer 2

The issuer may not meet its obligation to pay either the interest payments or the amount due on redemption. This is known as credit risk.

Question 3

What are index-based bonds?

Answer 3

Bonds where the initial interest payment & eventual principal repayment are uplifted periodically by the rate of inflation.

Question 4

What are call provisions?

Answer 4

These allow the issuer of the bond to repay the bond earlier that its planned maturity date.

Question 5

What are put provisions?

Answer 5

These allow the investor to require the issuer to repurchase the bonds at a specified time prior to maturity.

Question 6

What does ‘par’ refer to when talking about bonds?

Answer 6

Par refers to the nominal value of the bond, so if an investor subscribes to a new issue of a bond which is issued at par, then each $1.00 nominal of the bond that they buy will be priced at $1.00

Question 7

What is a bond’s nominal value?

Answer 7

It is the price at which the bond is usually issued and redeemed.

Question 8

What are the two categories of bond issues that are subject to credit ratings?

Answer 8

Those accorded an investment grade rating

Those categorised as non-investment grade or speculative (high yield or junk bonds)

Question 9

What rating to bonds have to be to be considered as investment grade?

Answer 9

BBB or above

Question 10

What is a running yield?

Answer 10

Also known as the flat or interest yield, the running yield expresses the coupon as a percentage of the market (or clean) price of the bond.

Question 11

What is the equation for working out a running yield?

Answer 11

Running yield = (coupon/clean price) x 100

Question 12

What is the disadvantage of the running yield?

Answer 12

It ignores the difference between the current market price and the redemption value.

Question 13

What is the gross redemption yield?

Answer 13

It is a combination of the running yield plus the gain or loss that will occur if the bond is held until it is redeemed, to give an annual compound return.

Question 14

What is the formula for the gross redemption yield (GRY)

Answer 14

GRY =

Running Yield + ( (Par-market price) / number of years to redemption)
( /Market price )

                                                             X 100

Question 15

What is reinvestment risk?

Answer 15

The inability to reinvest coupons at the same rate of interest as the GRY

Question 16

What is the inverse relationship between interest rates and bond prices?

Answer 16

When interest rates rise, prices of outstanding bonds fall

When interest rates fall, prices of outstanding bonds rise