Bond Basics

Question 1

Series Bond

Answer 1

Bonds have the same maturity but different issuance dates. Used for construction projects.

Question 2

Bond Pricing

Answer 2

Term Bonds = % of par (dollar bonds)

Serial Bonds = yield basis

Question 3

Basis Points

Answer 3

1 basis point = .01%

100 basis points = 1%

Question 4

How do you find the price of a long term serial bond quoted on a yield basis?

Answer 4

Coupon/Basis

4% Coupon/5% Basis = 80% of $1000 par = $800

Question 5

Effect of interest rate on bond prices

Answer 5

When interests rates RISE, bond prices FALL.

When interest rates FALL, bond prices RISE.

Question 6

What sort of bonds are the exhibit the most price volatility?

Answer 6

Long term, low coupon

Question 7

What is duration?

Answer 7

Measure of price volatility - high duration = high volitility

Question 8

Current Yield Formula

Answer 8

Annual Interest in Dollars/Bond’s Market Price

Question 9

Nominal Yield

Answer 9

Stated interest rate on bond

Question 10

Yield to Maturity Formula

Answer 10

Annual Income + Annual Capital Gain or - Annual Capital Loss)
/
Average Price = (Purchase Price + Redemption Price)/2

Capital Gain = amount of discount/years to maturity
Capital Loss = amount of premium/years to maturity

Question 11

What does a call feature do to market price?

Answer 11

Establishes a ceiling

Question 12

What does a put feature do to market price?

Answer 12

Establishes a floor

Question 13

Yield to Call or Put Formula

Answer 13

Annual Income + Annual Capital Gain or - Annual Capital Loss)
/
Purchase Price + Call or Put Price)/2

Capital Gain = amount of discount/years to maturity
Capital Loss = amount of premium/years to maturity

Question 14

S&P Bond Ratings

Answer 14

Investment Grade
AAA
AA
A
BBB

Speculative Grade
BB
B
CCC
CC
C

Question 15

Moody’s Bond Ratings

Answer 15

Investment Grade
Aaa
Aa
A
Baa

Speculative Grade
Ba
B
Caa
Ca
C

Question 16

Moody’s Commercial Paper Ratings

Answer 16

Actively Traded
P1
P2

Not Traded
P3
NP

Question 17

Moody’s Municipal Notes Ratings

Answer 17

Actively Traded
MIG 1
MIG 2

Not Traded
MIG 3
SG

Question 18

Interest Rate Risk

Answer 18

Risk that rising interest rates will cause bond prices to fall. Long-term maturities, low coupon rate bonds and deep discount bonds are most susceptible. Also called market risk.

Question 19

Purchasing Power Risk

Answer 19

Risk that inflation will lower the value of the bond interest payments and principal repayment. Most significant for long-term bonds. Also called inflation risk.

Question 20

Marketability Risk

Answer 20

Risk that the security will be difficult to sell.

Question 21

Liquidity Risk

Answer 21

Risk that the security can only be sold by incurring large transaction costs. The longer the maturity, the less liquidity

Question 22

Legislative Risk

Answer 22

Risk that new laws reduce the value of the security

Question 23

Call Risk

Answer 23

Risk that the bond may be redeemed prior to maturity.

Question 24

Reinvestment Risk

Answer 24

Risk that bond interest repayments will be reinvested at lower interest rates, lowering the overall return from the bond.

Question 25

Exchange Rate Risk

Answer 25

Risk that the value of the foreign currency weakens or the dollar strengthens.

Question 26

Political Risk

Answer 26

Risk of investing in foreign countries with weak political and legal systems.

Question 27

How does the yield curve look in different economic cycles?

Answer 27

Expansion: Curve is ascending
Peaking: Flat Curve
Overheating: Inverted Curve

Question 28

What does a yield curve do before a recession or expansion?

Answer 28

Recession: Yield spread between corporate and government bonds will WIDEN
Expansion: Spread will NARROW