Bond And Money Market

Question 1

Characteristics of an investment

Answer 1

SYSTEM T

1. Security - default risk
   *default prob
   *reputation
2. Yield - real/nominal expected return
   2.1real/nom
   *Risk
   *fixed vs variable vs linked
   *reinvestment
   *mid - term sale
   *uncertain real return
   2.2 expected return
   *Risk vs return
3. Spread- volatility of market values
4. Term - short medium long
5. Expenses/exchange rate
   *currency risk
6. Marketability
   *ability to buy and sell
7. Tax
   ?what is the institution are they exempt
   *income.and capital gains

Question 2

Common investment classes

Answer 2

1. Cash on deposit
2. Money market
3. Fixed interest
4. Index-linked interest
5. Equity
6. Property

Question 3

Cash on deposit

Answer 3

1. Call deposit
   *instant access
2. Notice deposit
   *give notice period
3. Term deposit
   *fixed term, no access

Question 4

Clearing banks role

Answer 4

Liquidity
*lend excess cash to them
*borrow when low on cash

Question 5

Central bank

Answer 5

1. Lenders of last resort - providing liquidity
2. Use operations in mm to establish level of short term interest rates
3. Sale or purchase of treasury and other bills
4. Provide liquidity to banking system

Question 6

Money market -reasons for holding cash (liquidity)

Answer 6

A SOUP
1. Awaiting to invest after receiving cashflow
2. Short term commitments
3. Take advantage of investment opportunities
4. Prepared for uncertain outgo
*general insurance
5. Protect monetary value
*Risk aversion

Question 7

Money market - reasons to hold cash

Answer 7

1. Liquidity
2. Poor economic outlook

Question 8

Money market - reasons to hold cash (economic outlook)

Answer 8

GRID
1. Genral economic uncertainty
*stability of capital values - risk averse
*less risky -> less return
2. Economic recession (start)
*lower growth
*increasing government deficit
*cash more stable
3. Rising interest
*depress economic activity (equity and bonds)
*capital loss
*higher nominal income - attractive for investment
4. Weakening domestic currency
*makes international cash investments attractive
*Inc interest to protect currency -> lower cap val

Question 9

Distinct types of bond markets

Answer 9

1. Government
2. Corporate
3. Overseas

Question 10

Fixed interest bond definition

Answer 10

Aka conventional bond
Gives income stream and final redemption proceeds that are fixed in monetary terms

*government borrowing
*corporate financing

Question 11

Index linked bond definition

Answer 11

Gives income stream and final redemption value that is linked to an inflation index

*real terms
*lag in the indexation -> no protection in last months before redemption

Question 12

Gross redemption yield

Answer 12

*return investor expects to receive if they hold bind to maturity
*assumes reinvestment of coupons at exact same rate
*ignores expenses, tax and default risk

Question 13

Valuing index linked

Answer 13

1. Future inflation rate - price index used to index coupons and redemption
2. Coupon and capital repay - nominal
3. Outstanding term of index linked bond
4. Value of price index used to calc value of next coupon
5. Time to next cousin
6. Yield to discount future cashflows

Question 14

Nominal yield

Answer 14

Risk free real yield + expected future inflation + inflation risk premium

Question 15

Inflation risk premium

Answer 15

*additional yi3ld required by investors with real liabilities
*bearing risk of uncertain future inflation
*size determine by
>degree of uncertainty
>number investors requiring fixed vs number investors requiring real