Bond Duration Flashcards
What is Current Yield?
The interest rate of the bond at its current price.
Coupon payment ÷ price.
What is Yield to Maturity?
Yield to M. Is the compounded rate of return if an investor buys a bond today and holds it until maturity. It assumes reinvestment of interest payments at the yield to maturity rate. It is useful in comparing possible bond purchases.
How do you approach yield to maturity problems?
TVM calculation solving for I. Use the interest rate given to calculate the payment. Divide payment by 2. Multiply N by 2. Multiply I by 2 after you solve for it (Assuming semiannual compounding).
What is yield to call?
How do you do yield to call problems?
Compounded return until a bond is called at its call price.
Same as YTM, but use the call price as FV, and the years until call (x 2) as N.
What is the Achilles’ heel of YTM and YTC problems?
You have to double the interest rate after you solve for it.
What is indicated by, “If you see a discount, call mom’s cell now.”
The ranking of yield measures for a discounted bond. Yield to call is highest (discounted bonds aren’t called), yield to maturity is next, followed by the coupon rate and the nominal rate.
For a premium bond it’s the opposite: Nominal is highest, followed by current, YTM, YTC.
All yields are the same for a bond selling at par.
What is accrued interest? How is it paid? What are the tax implications?
When you purchase a bond, you must pay the seller the interest accrued since the last payment. You will receive the interest payment and be taxed on it, but you can claim a deduction for what you paid the seller.
What is the best type of account to hold zero coupon bonds?
Zeroes create phantom income on which you pay tax. Hold them in a tax deferred account.
What are the three yield curve theories?
- Liquidity preference: consumers prefer liquid, and long-term investments have higher risks, so long-term bonds pay more interest.
- Market segmentation: the yield curve has 3 segments, each with their own market dynamic.
- Expectations: yield reflects investors inflation expectations. Since the future is usually murkier, long-term rates are usually higher. When inflation is expected to be lower in the future, long-term rates will be lower.
What is the unbiased expectations theory?
The idea that today’s long-term rates are a geometric average of the current rates and future interest rates. The formula for this is on the sheet.
What is bond duration?
The moment in time when an investor is immunized from interest rate risk and reinvestment rate risk.
What is the relationship b-t bond duration and volatility (price sensitivity)?
The higher the duration, the more the bond is price-sensitive to interest rate changes.
What is modified duration?
A bond’s price sensitivity to changes in interest rates.
What duration should an investor seek in his bond portfolio?
Portfolio duration should equal his time horizon for him to be fully immunized.
What is the duration of a zero-coupon bond?
For zeroes, duration always = maturity.
