Bond Basics Flashcards
Series Bond
Bonds have the same maturity but different issuance dates. Used for construction projects.
Bond Pricing
Term Bonds = % of par (dollar bonds)
Serial Bonds = yield basis
Basis Points
1 basis point = .01%
100 basis points = 1%
How do you find the price of a long term serial bond quoted on a yield basis?
Coupon/Basis
4% Coupon/5% Basis = 80% of $1000 par = $800
Effect of interest rate on bond prices
When interests rates RISE, bond prices FALL.
When interest rates FALL, bond prices RISE.
What sort of bonds are the exhibit the most price volatility?
Long term, low coupon
What is duration?
Measure of price volatility - high duration = high volitility
Current Yield Formula
Annual Interest in Dollars/Bond’s Market Price
Nominal Yield
Stated interest rate on bond
Yield to Maturity Formula
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
What does a call feature do to market price?
Establishes a ceiling
What does a put feature do to market price?
Establishes a floor
Yield to Call or Put Formula
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
S&P Bond Ratings
Investment Grade AAA AA A BBB
Speculative Grade BB B CCC CC C
Moody’s Bond Ratings
Investment Grade Aaa Aa A Baa
Speculative Grade Ba B Caa Ca C
Moody’s Commercial Paper Ratings
Actively Traded
P1
P2
Not Traded
P3
NP
Moody’s Municipal Notes Ratings
Actively Traded
MIG 1
MIG 2
Not Traded
MIG 3
SG
Interest Rate Risk
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.
Purchasing Power Risk
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.
Marketability Risk
Risk that the security will be difficult to sell.
Liquidity Risk
Risk that the security can only be sold by incurring large transaction costs. The longer the maturity, the less liquidity
Legislative Risk
Risk that new laws reduce the value of the security
Call Risk
Risk that the bond may be redeemed prior to maturity.
Reinvestment Risk
Risk that bond interest repayments will be reinvested at lower interest rates, lowering the overall return from the bond.
Exchange Rate Risk
Risk that the value of the foreign currency weakens or the dollar strengthens.
Political Risk
Risk of investing in foreign countries with weak political and legal systems.
How does the yield curve look in different economic cycles?
Expansion: Curve is ascending
Peaking: Flat Curve
Overheating: Inverted Curve
What does a yield curve do before a recession or expansion?
Recession: Yield spread between corporate and government bonds will WIDEN
Expansion: Spread will NARROW
