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CP1 Flashcards > 8 - Bond and Money Markets > Flashcards

8 - Bond and Money Markets Flashcards

1
Q

What does the term money markets cover? (2)

A
  • Bank Deposits

- Short Term Securities

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2
Q

Money market instruments can be issued by (4)

A
  • Government (treasury bills)
  • Regional government bodies (local authority bills)
  • Companies (bills of exchange, commercial paper)
  • Banks (different types of deposit)
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3
Q

4 Types of bank deposits

A
  • call deposits
  • notice deposits
  • term deposits
  • certificates of deposit
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4
Q

Call deposits

A

Depositor has “instant access” to withdraw funds

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5
Q

Notice deposits

A

Depositor has to give a period of notice before withdrawal

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6
Q

Term deposit

A

Depositor has no access to the capital sum earlier than the maturity of the deposit.

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7
Q

Certificates of deposit characteristics

A
  • Tradable notes.
  • Short term security issued by banks showing a stated amount of money has been deposited for a specified term and rate of interest.
  • Interest payable on maturity
  • Kind of like a tradeable term deposit
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8
Q

10 Investment and risk characteristics of money market instruments

A
  • Normally good security as term is very short, depends on the borrower though
  • Return is through income
  • Level of income has a loose, indirect link with inflation
  • Lower expected returns than equities or bonds over the long term
  • Stable market values
  • Short-term
  • Low dealing expenses
  • Liquid
  • Normally highly marketable
  • Returns normally taxed as income
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9
Q

Who are the participants in the money market?

A
  • Clearing banks
  • Central banks
  • Companies
  • Individuals
  • Other financial institutions & non-financial companies
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10
Q

Clearing banks as players in the money market

A

Use money market instruments to lend excess liquid funds and to borrow when they need short-term funds

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11
Q

Central banks as players in the money market

A
  • Act as lenders of last resort
  • Stand ready to provide liquidity to the banking system when required
  • Buy and sell bills to establish the level of short-term interest rates
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12
Q

Uses of Money Market Instruments (why do investors hold them?)

A 
P - Protect market value
O - Opportunities may occur, liquid
U - Uncertain outgo/ liability
R - Recently received cashflow
S - Short-term liability
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13
Q

When are money market instruments attractive for institutions and investors?

A

G - general economic uncertainty.

R - start of recession (a fear that equity and bond prices will fall)

I- interest rates rising (might cause other asset values to fall)

D - the domestic currency to weaken (makes overseas cash holdings attractive. And it may be followed by rising interest rates)

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14
Q

Circumstances under which money market instruments would be temporarily unattractive

A
  • flip the reasons for grid around
  • General economic Certainty
  • Expectations of falling interest rates
  • The end of a recession / start of a boom
  • Expectations of a strengthening domestic currency
  • If the investor is not risk averse or not concerned with liquidity
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15
Q

Main risks for an institutional investor with all their assets in domestic money market instruments

A
  • Cash instruments are short-term investments => there is a mismatch by term with the investor’s liabilities
  • Investor’s assets will have to be reinvested many times at currently unknown future interest rates (high level of reinvestment risk)
  • Lower expected return than other assets
  • Holding all assets in one type of investment results in a lack of diversification. All the investments will be positively correlated, resulting in a concentration of risk
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16
Q

‘Bond’ is an alternative term for:

A

Fixed-interest or index-linked security

17
Q

How are bonds described?

A
  • Organisation issuing the security (govt, corporate, local authority)
  • Nature of the bond (fixed-interest or index-linked)
  • Overseas or domestic (think currency risk)
18
Q

Gross redemption yield (GRY) definition

A

The return the investor would expect to get on a bond if they held it until redemption

19
Q

What are the investment and risk characteristics to consider?

A 
S - Security
Y - Yield
S - Spread (volatility in value)
T - Term
E - Expenses (dealing)
M - Marketability
A - Asset specific (index-linked?)
T - Tax
I - Intricacy (redeemable for diff. asset? floating rates?)
C - Currency
20
Q

Fixed-interest government bond characteristics?

A

S - Highly secure if govt. is stable
Y - Expected long-term yield of equity is higher
S - Long-term bonds can be highly volatile
T - Terms can be of a wide range
E - Low dealing expenses (equities have greater dealing exp.)
M - Highly Marketable (majority of market)
A -
T - Tax charged on coupons as income tax + capital gains tax
I -
C - Usually issued in domestic currency but not always

21
Q

Difference between index-linked government bonds and fixed-interest government bonds characteristics?

A
  • IL bonds are less volatile than fixed-interest bonds as they are protected against inflation
  • Issues are small so not a wide variety of terms
  • IL bonds are less marketable (smaller issues of IL bonds)
22
Q

Corporate bond characteristics

A

S - Security depends on rating of the company
Y - Yield is fixed or floating, GRY is rating dependent
S - Can be volatile depending on company rating
T - Term can be of wide ranges (typically shorter than govt bonds)
E - Expenses are low
M - Marketability depends on size of issue
A - Sometimes bonds can have callable options
T - Tax charged on income & capital gains
I - Intricacy (redeemable for equity? floating rates?)
C - Currency is usually domestic

23
Q

What are the different types of corporate bonds?

A
  • Secured loan stock (debentures, mortgages)
  • Unsecured loan stock
  • Subordinated debt (lowest ranking debt)
  • Convertible bonds (convert to equity shares in a company)
24
Q

Nominal yield on conventional govt. bonds can be expressed as:

A

Nominal yield = risk-free yield + expected future inflation + inflation risk premium

25
Q

What does the size of inflation risk premium depend on?

A
  • Inflation uncertainty

- Balance between investors who require real returns and those that require fixed returns (demand)

26
Q

Monetary risk premium

A

Risk premium added onto the yield of index-linked bonds for risk of inflation being lower than expected and required nominal return not being achieved

27
Q

How to estimate the market’s expectations for inflation?

A
  • The difference b/w nominal and real yields (ignoring inflation risk premium)
28
Q

What will cause the value of fixed interest bonds to increase?

A
  • If Investors expectations for future inflation fall

- Inflation risk premium falls

29
Q

What are economic circumstances under which inflation becomes more uncertain?

A
  • Less government commitment to a low inflation environment
  • Loose monetary policy
  • Devaluation of the domestic currency
  • Rapid economic growth

CP1 Flashcards (26 decks)

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