AFMA Debt Markets: Exam tips Flashcards

1
Q

To manage liquidity, the RBA uses which of the following:

  1. Foreign exchange swaps
  2. Purchases / sales of long dated CGS
  3. Interest Rate swaps
  4. Repurchase/reverse repurchase transactions

a) 1, 2, 3 & 4
b) 1, 2 & 3
c) 2 and 4
d) 1, 2, and 4

A

d) 1, 2, and 4

(Does not use IRS - there is no exchange of principle

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2
Q

Which of the following is a typical task of the Australian Offic e of FInancial Management?

a) provide portfolio management for state-owned corporations
b) provide intraday liquidity to ESA holders
c) operate a stock lending facility through the RBA
d) Raise long and short term funds for wholesale institutions

A

c) operate a stock lending facility through the RBA

(note elimination: PM for state owned corps = semis, intraday liquidity for ESA holders is RBA, long and ST funds for wholesale instos = banks)

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3
Q

Which of the following participants is a price maker?

a) Jess accepts a bid rate of 3.50% for a bond issue
b) Bill quotes a rate of 4.30/4.25 for a 10 year bond
c) Steel Corporation issues $100,000 worth of promissory notes
d) EFG Life pools its premiums and invests in asset backed securities

A

b) Bill quotes a rate of 4.30/4.25 for a 10 year bond

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4
Q

Short term debt products:

  • define
  • consist of:
A

Short term debt products:

  • define: < 1 year to maturity
  • consist of:cash products; discount securities
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5
Q

Cash markets - products (4)

A
  1. Exchange Settlement Accounts (ESAs)
  2. At call funds (or 11am cash)
  3. Term loans and deposits
  4. Interest calculated on a simple interest basis
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6
Q

Future Value vs Present Value:

Formula

A

FV = PV + (PV x i x t)
= PV (1 + it)

PV = FV / (1+it)

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7
Q

Discount Securities:
Characteristics (2)
Major forms (4)

A

Discount Securities:
Characteristics (2)
- Securities that only pay a single payment at a specific date in the future
- Trade at a discount to their face value
Major forms (4)
- Bank Accepted Bills (BABs) (drawer, acceptor, payee)
- Commercial Paper (aka Promissory Notes) CP / PN (bearer)
- Negotiable Certificates of Deposit (NCDs) (bearer)
- Treasury Notes (T Notes) (inscribed stock)

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8
Q

BABs
Bills of Exchange Act 1909
1. types
2. parties to a bill of exchange:

A
BABs
Bills of Exchange Act 1909
1. types
- bills of exchange
- bank endorsed bills
- bank accepted bills
2. parties to a bill of exchange:
- drawer
- acceptor
- payee
- discounter
- endorser
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9
Q

CP / PNs / NCDs

6 characteristics

A
CP / PNs / NCDs
6 characteristics
- one name paper
- bearer instrument
- details of paying bank included
- CP/PNs issued by corporates/funding vehicles
- NCDs issued by ADIs
- ECP is issued outside borrowers country
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10
Q

Treasury Notes

4 characteristics

A
Treasury Notes
4 characteristics
- Issued by AOFM on a tender basis
- Maturities up to 9 months
- Discount securities
- Inscribed stock
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11
Q

Pricing Discount Securities: formula

A

Price = Face Value / (1+i * d/365)

Express i as decimal

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12
Q

Capital gain or loss: formula

A

Capital gain = Selling Price - (Purchase price + interest)

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13
Q

Repos and Reverse Repos

  • define
  • used for:
  • repo margining:
A

Repos and Reverse Repos
- define: transaction involving a purcashe or sale of a security and the simultaneous agreement to reverse the transaction at an agreed date and price in the future

  • used for: repos are used as a tool for short term liquidity management
  • repo margining:
    Default practice is to make margin calls in preference to repricing transaction when relying on repo agreements to cover exposure between parties
    Collateral securities are valued on a daily basis and compared to net cash borrowed by counterparty to determine if margin calls are to be made
    Repricing is still permitted provided it is agreed by the counterparties
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14
Q

Which of the following statements are TRUE

1) All short term discount instruments are payable to bearer
2) The minimum bid size for treasury notes at an RBA tender is $1,000,000
3) All discount instruments have a fixed face value
4) Promissory notes do not have an acceptor

a) 1, 3 and 4
b) 1 and 2
c) 2, 3 and 4
d) 3 and 4

A

c) 2, 3 and 4

Note: 1: inscribed stock is different

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15
Q
MUST KNOW THIS:
An investor purchases a$1m Bank Bill at a yield of 5% with 90 days to maturity.  If he sells it 20 days later at a yield of 4.85%, what is the capital gain earned?
a) 256.61
b) 2,962.97
c) 2,706.36
d) 237.20
A

a) 256.61

Question is asking what is the capital gain or loss. Watch: this is a 2 step process. You need to work out the interest on the principle

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16
Q

Exam question:

Understand concept of bonds trading at par, premium and discount

A

kjlkjlklkj

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17
Q

Long term debt markets:

Instruments

A
  • Commonwealth Govt securities (issued by AOFM on tender basis)
  • Semi government bonds (issued by semis, via tender or dealer panel)
  • Non govt securities
  • foreign bonds (kangaroos)
  • FRNs
  • Indexed bonds (capital indexed, coupon indexed)

OTHER

  • Eurobonds
  • ABS (incl RMBS, bullet or pass through)
  • CDOs
  • Subordinated securities
  • Hybrid securities (reset securities, convertible notes, warrants)
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18
Q

Which of the following statements is TRUE about the cash flow involved in fixed interest securities?

a) The type of cashflow on a fixed interest security depends on whether the security was issued at a premium or discount to par
b) Fixed interest securities have one type of cashflow repayment of principle at maturity
c) The types of cashflow on a fixed security depend on the issuer of the security
d) Fixed interest securities have 2 types of cashflow: coupon cashflow and repayment of principle at maturity

A

d) Fixed interest securities have 2 types of cashflow: coupon cashflow and repayment of principle at maturity

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19
Q

What is the gross price per $100 face value of the following CGS for settlement on 18 April 2012?
Maturity = 15 March 2015
Coupon = 6.75% (paid semi annually)
Yield = 5.62%

a) 102.986
b) 103.609
c) 103.08
d) 102.602

A

b) 103.609

note question asks for GROSS price no capital price.

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20
Q
Calculate the yield (to 2 decimal places) for the following CGS for settlement 18 April 2012
Capital Price: 102.986
Maturity: 15 March 2015
Coupon: 6.75% (paid semi annually)
a) 5.50
b) 5.62
c) 5.26
d) 6.75
A

b) 5.62

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21
Q

EXAM QN (3 qns in exam, one is FV, one is PV, one is no formula)

The present value of $400 in three year’s time at an annual interest rate of 6.5% with semi annual interest payments is

a) 478, as interest is not reinvested
b) 274.13 assuming interest payment are re invested
c) 330.16 assuming interest payments are reinvested
d) 426

A

c) 330.16 assuming interest payments are reinvested

PV = FV / ((1+i)^n)

= 400 / ((1+0.065)^6)
= 330.16

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22
Q

Forward Rate Agreements

What does “the 16th” or “the 2nd” mean

A

Means the 16th day of the month, or the 2nd day of the month.
eg 1s/4s the 16th.

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23
Q

Interest rate swaps

Swaps are used to: (6)

A
  1. obtain lower cost of funding for borrowers
  2. , hedge an interest rate exposure
  3. obtain higher yielding investment assets
  4. create types of investment assets not otherwise obtainable
  5. implement overall asset/liabilities management strategies (eg change characteristics of portfolio without changing physical composition
  6. Take speculative positions in relation to future movement in interest rates
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24
Q

The present value of any future cashflow is the discuont factor (DF) multiplied by the future value (FV)

A

PV = DF x Future Value

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25
Q

Types of swaps (5)

A
  1. Accreting
  2. Amortising
  3. Basis
  4. Balloon
  5. Forward Swap
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26
Q

Overnight Index Swaps

- Define

A

OIS

  • Fixed rate swap against a floating rate index which is the overnight cash rate compounded daily
  • Allows overnight interest rate exposure to be managed off balance sheet freeing up credit
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27
Q

Currency Swaps - types (3)

A

Types of currency swaps:

  1. Currency swap - fixed vs floating
  2. Cross currency swap - fixed vs floating
  3. cross currency basis swap - floating vs floating
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28
Q

Currency swap components (3 points on exchange)

A
  1. Initial exchange:
    - usually set at spot rate
    - sets notional amounts for interest payments
  2. Interest payments
    - paid periodically based on notionals set at initial exchange
  3. Final exchange
    - principals exchanged at the same rate as initial exchange
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29
Q

What are the key features of 90 day bank bill futures (4)

A
  1. deliverable
  2. 1m face value
  3. Mar Jun Sep Dec
  4. Tick value series
30
Q

Question: If worries about rates in 3 months time, what would you use

A

Consider 90 day bank bill futures or FRA. Check direction (of exam question)

31
Q

What are the key features of 3 and 10 year bond futures (4)

A
  1. non deliverable
    - 100K
    - Mar Jun Sep Dec
    - Tick value varies
32
Q

30 day interbank cash rate futures

5 characteristics

A
  1. Cash settled (overage of daily overnight rate over month)
  2. Monthly dates (last trade date end of month, settled 2nd business day after
  3. 3m notional
  4. Priced as 30 days simple interest (fixed tick value of 24.66
  5. Quoted as 100 minus yield
33
Q

Exchange for Physical

A
  • off market agreement between tow counterparties to exchange futures for physical instruments
  • majority of interbank bond and swap trading is on an EFP basis
  • both legs executed simultaneously with volumes risk matched
34
Q

EXAM QN:
A bank pays a 2/5s the 2nd FRA on the 5th of March. What have they done?
a) Pay fixed for 3 months out of the 5th of March, receive floating against 3 month BBSW on 5th May
b) Receive fixed for 5 months out of 5th March, pay floating against 3 month BBSW on 2nd May
c) Receive fixed for 3 months out of 2nd May, pay floating against 3 month BBSW on 2nd May
d) Pay fixed for 3 months out of 2nd May, receive floating against 3 month BBSW on 2nd May

A

d) Pay fixed for 3 months out of 2nd May, receive floating against 3 month BBSW on 2nd May

note terminology “the second’

35
Q

EXAM QN:
Which of the following is TRUE about OIS
a) Interest is calculated and paid daily
b) Interest is compounded daily and netted with the interest on the fixed leg on the day following maturity
c) Interest is compounded monthly and netted with the interest on the fixed leg on the day following maturity
d) Interest is calculated daily and paid monthly

A

b) Interest is compounded daily and netted with the interest on the fixed leg on the day following maturity

NOTE the index for OIS is NOT BBSW, it is RBA30. 4.30pm clearing system is closed

36
Q

EXAM QN:
If you were recommending a strategy to a client using interest rate swaps, which of the following reasons would apply?
a) To access higher yielding investment
b) To hedge a portfolio of risk
c) To speculate on the future movement on interest rates
d) All of the above

A

d) All of the above

37
Q
Option Terminology:
Define
Put option:
Call option:
Strike or exercise price:
European Style:
American Style:
intrinsic Value
Time value:
In the money
at the money
out of the money

Swaption

A

Put option: right to buy
Call option:right to sell
Strike or exercise price: price at which may exercise right
European Style: exercise at end (expiry)
American Style: exercise anytime before expiry
intrinsic Value: profit if option exercised immediately (positive only)
Time value: difference between current premium and intrinsic value
In the money: option has positive intrinsic value
at the money: strike price is the same as the current market price
out of the money: strioke price is worse than current market price

Swaption: option on a swap

38
Q
Swaptions
- define
- payers swaption = 
- receivers swaption = 
Example, borrower hedging upcoming bond issue; or fixed rate borrower hedging against falling interest rates
A

Swaptions

  • define: option to enter into a swap
  • payers swaption = right to pay fixed
  • receivers swaption = right to receive fixed
39
Q

List option pricing models

A
  • black scholes
  • black
  • binomial
  • monte-carlo
  • interest rate specific (eg Hull-White, Brace - Gaterek-Musiela (BGM) aka Libor Market Model
40
Q

Volatiltiy

  • define:
  • define historic volatiltiy
  • define imp;lied volatility
A

Volatiltiy
- define: standrad deviation of the underlying market (in Black Scholes, refers to SD of the log of the daily returns of the underlying market)

  • define historic volatiltiy: observed volatiltiy over a period
  • define implied volatility: volatility implied in the market option price (ie the volatility expected over the option term
41
Q

Delta =
Gamma =
Theta =
Vega =

A
Delta = change in premium with respect to change in underlying market price
Gamma = change in delta with respect to change in underlying market price
Theta = change in premium with respect to time
Vega = change in premium with respect to change in volatility
42
Q

Credit derivative types: (4)

  • credit default swaps
  • credit linked notes
  • total (rate of) return swaps
  • credit swap options
A
  • credit default swaps
  • credit linked notes
  • total (rate of) return swaps
  • credit swap options
43
Q

CDS (NOTE - important for exam)
Protection Buyer:
Protection seller:

A

Protection Buyer: pays fixed rate premium
Protection seller: pays floating payment contingent on defined credxit event occuring. Settlement may be physical or cash

If you buy protection, you pay a fixed premium and receive a floating benefit.

44
Q

EXAM QN:
Consider an option on a 10 year physical bond, and an exchange traded 10 year bond futures option contract with the same expiry date.
Which of the following statements is correct:
a) The premium on both are quoted on the same basis
b) The premium will be paid on the same date
c) Market movements in premiums can vary between the two because they are options on two different underlying instruments
d) Neither can be exercised prior to expiry

A

c) Market movements in premiums can vary between the two because they are options on two different underlying instruments

(Note: 1 is OTC, the other is exchange traded).

45
Q

EXAM QN:
What are credit derivatives most commonly used for?
a) to manage market risk
b) to manage interest rate risk
c) to manage credit exposures / risk
d) to increase the returns on your investment

A

c) to manage credit exposures / risk

46
Q

Interest Rate Risk

Name 3 risks

A
  1. Outright risk (measured as parallel curve shift)
  2. Curve risk (non parallel yield curve shift)
  3. Basis risk (risk arising from underlying risk moving differently to hedging tool (credit risk, futures basis risk)
47
Q

Other risk considerations:
Term to maturity: the longer the term to maturity the …
Coupon: the lower the coupon the greater the …
Liquidity: the greater the liwuidity the lower…

A

Other risk considerations:
Term to maturity: the longer the term to maturity the greater the price sensitivity to yield changes
Coupon: the lower the coupon the greater the price sensitivity to yield changes
Liquidity: the greater the liquidity the lower the relative yield

48
Q

Measuring interest rate risk (7)

A
  • gap analysis
  • present value of a basis point
  • duration
  • convexity
  • absolute measures
  • equivalent position methodology
  • value at risk
49
Q

Present Value of a Basis point

  • define / calculate
  • commonly expressed as:
  • calculated using xxx shift in yield curve
A

Present Value of a Basis point

  • define / calculate: Calculate the $ change per 1bp (0.01%) move in yield (eg $0.027 per $100 FV)
  • commonly expressed as: $ per bp per $1m FV
  • calculated using parallel shift in yield curve
50
Q

Modified Duration:

  • define
  • calculation
A
  • modified duration measures the percentage change in bond price for a 1% change in yield
  • MD = 1 / (1 + i/k) * Macauley duration
    i = bond yield
    k = coupon frequency
51
Q

Modified duration - - example
If the duration (macauley) of a 2 year semi annual bond with a coupon of 8% pa and yield of 6% is 1.8898, the modified duration is calculated as …..

In this example, if the yield of the bond changes by 100bps, the value of the bond will….

A

= 1 / (1+0.06/2) * 1.8898
= 1.8348

If the yield rises by 100bps, value will fall by 1.8348% (and vice versa)

52
Q

Convexity
Convexity exhibits the following characteristics:
(3)

A
  1. the longer the maturity of the bond, the greater the convexity
  2. the lower the coupon rate, the greater the convexity
  3. the lower the yield, the greater the convexity
53
Q

Value at Risk

A
  • based on assumptions of volatility and correlation regarding individual securities and asset classes
  • limits imposed based on losses for given confidence levels (say 95%)
54
Q

Managing risks: market makers (5)

A
  1. Product limits
  2. Risk limits (eg PVBP, bucket, VaR)
  3. Credit limits
  4. Tactical quoting
  5. Manage positions acquired through price making (do nothing, hedge, trade out)
55
Q

Managing Risk: Price taker

A
  1. Only acquires desired risk (tactical trading, strategic, technical)
  2. Limits based on risk and capital allocated for trading
56
Q
EXAM QN:
John is a bond trader at Bravo Bank.  He is short bonds and he believes the yield curve will move up.  Based on this expectation, what is John's trading strategy likely to be:
1. Buy bonds to gain a long position
2. Hold the short position
3. Buy bonds to square up the position
4. Go long at the short end of the curve
A
  1. Hold the short position
57
Q

EXAM QN: (ensure rounding is 3dp as per bond convention)
What is the PVBP of a FV$10,000,000 three year bond with a 7% coupon at yields to maturity of 5% and 5.01%pa
a) (-) $2,800
b) (+) $2,800
c) (+) $1,600
d) (-) $3,200

A

a) (-) $2,800

  1. 508 at 5.00%; $10,550,800
  2. 480 at 5.01%; $10,548,000

Difference = -2800

58
Q

Retail client disclosures

  • Documents (3)
  • Warnings (2)
A

Retail client disclosures

  • Documents (3)
    1. PDS
    2. Financial Services Guide (explains what the licensee is able to provide)
    3. Statement of Advice (what personal advice has been provided, why and any influences
  • Warnings (2)
59
Q

Suitability of Advice (3)

A
  1. Must have a reasonable basis for advice
  2. Addresses suitability of advice provided
  3. Advice must be appropriate
    - have regard for client personal circumstances in relation to the advice (know your client)
    - know your product
60
Q

ASIC Requirements Reg 146

Nine stages

A
  1. Establish relationship with client
  2. Identify needs, objectives and financial situation
  3. Analyse needs, objectives and financial situation and risk profile
  4. Develop appropriate strategies and solutions
  5. Present appropriate strategies and solutions
  6. Negotiate a plan or transaction with client
  7. Coordinate implementation
  8. Complete & maintain any documentation
  9. Provide ongoing service where requested
61
Q

EXAM QN:
You need to prepare an SOA for a client. What as a minimum should it contain?
a) product issuer details, product benefits and significant risks associated with the products, amounts payabkle and taxation implications
b) name and contact details of the trading participant, information regarding remuneration, information about the basis on which the advice is given
c) Date of the transaction and the description of the transaction
d) Internal and external complaint handling procedures and compensation arrangements

A

kjhkljhjh

62
Q

EXAM QN:
Bill is currently assistting a corporate client to develop a strategy for the implementation of a structured debt derivatives program. In order to do this Bill must:
a) Identify and assess alternatives based on the needs and profile of the client
b) Perform comprehensive research, modelling and analysis
c) Draft a plan for presentation to the client of the transaction
d) All of the above

A

gdgdfg

63
Q

Exam QN
Sam is an economist at Blue Ridge Investments. She is preparing an economic report to present to the board. Her report indicates that short term interest rates are expected to rise due to inflationary pressures and long term interest rates are expected to fall as economic activity slows down. Sam’s report indicates a:
(a) Inverse yield curve
(b) humped yield curve

A

Ans: (b) Humped yield curve

From text: Shape of curve is reflective of economic impact of interest rates. That is, interest rates are expected to rise in short term due to inflationary pressures (short term) then as a result of higher interest rates the economy may slow and push rates lower in long term
Humped curve can also be impacted by supply and demand for securities of a certain maturity

64
Q

An option has a delta of 100%. This means that the option:

A
  • is deep in-the-money and has no time value, only intrinsic value
65
Q

The primary difference between a bank accepted bill and a commercial bill is that:

A

a commercial bill has a higher credit risk

66
Q

Matt is the CFO of a small engineering practice. He needs to borrow short term funds at a fixed rate and wants to minimise credit risk. Which of the following debt products should Matt use:

A

Bank accepted Bill

67
Q

KAN Corporation has just transacted an overnight index swap. In this type of transaction, floating interest is compounded:

(a) daily, and netted with the interest on the fixed leg on the day of the maturity
(b) daily, and netted with the interest on the fixed leg on the day following the maturity

A

(b) daily, and netted with the interest on the fixed leg on the day following the maturity

68
Q

Ben is a trader and he believes long term interest rates are set to rise. He wants to hedge a 3 year government bond position, while at the same time profit from the expected rise in long term rates. Which of the following strategies would Ben choose:

(a) Sell a 3 year bond futures contract. If interest rates fall, Ben will have hedged his position, however he will not make a profit
(b) Sell a 10 year bond futures contract. If interest rates rise the yield curve steepens and Ben has hedged his position and profited from curve risk.

A

(b) Sell a 10 year bond futures contract. If interest rates rise the yield curve steepens and Ben has hedged his position and profited from curve risk.

69
Q

Repos

A

Repo = sell then buy
Reverse repo = buy then sell
Need to know who is repoing and who is reverse repoing.

the amount transferred is principal PLUS interest (not minus interest)

70
Q

Bond function in calculator

A
  • Calculator shows CAPITAL price, need to add this to the ACCRUED to get GROSS
71
Q

Possible exam question:

FV = 10m
Gross price = 10.128m
Settle = 18/9/13
Mature = 15/06/2016
Coupon = 6.25%

Was the bond issued at par, premium or discount?

A

Trap: there is no yield to calculate.
Therefore, calculate 1 month of interest:
10m x 0.0625 = 625,000/12 = 52,083
Multiply by 3 months: = 156,250

Compare with current gross price; can see that bond is at discount.

ie; work out the coupon interest accrued, and subtract this from the gross price