Bond Markets Flashcards
TIME VALUE OF MONEY
Value that an amount of money has at different periods of time.
NET PRESENT VALUE (NPV)
Difference between the PV of cash inflows and the PV of cash outflows over a period of time, calculated by discounting all the CF’s until t=0 at some interest rate.
DISCOUNTING
Process of converting a value received in the future to an equivalent value received immediately.
PERPETUITY
Stream of CF’s received continuously for an indefinite amount of time. (annuities that last forever)
ANNUITY
Series of payments received over equal time intervals.
BONDS
Financial documents issued by corporations/government/entities to raise capital in order to finance their businesses, which specify the terms and timing of a series of CF’s that the issuer offers to pay to the investors.
RELATIONSHIP B/W RATES AND PRICES
In order to obtain the price of fixed-income instruments, you need to get the PV of payments discounted at the proper interest rate.
INTEREST RATE YIELD CURVE
Represents the relationship b/w market interest rates and the remaining time to maturity of debt securities.
INTERNAL RATE OF RETURN (IRR)
Yield that makes the NPV of all CF’s equal to the market price of the bond.
Metric used to measure the profitability of an investment.
EFFECTIVE YIELD
Return on a bond that has its coupons reinvested at the same rate by the bondholder.
IRR = Effective Yield, when?
- Bond is held until maturity or bond is sold and you get the IRR during the life of the bond.
- You can reinvest the coupons at the IRR
CORPORATE BONDS
Bonds issued by corporations that offer a higher yield than government bonds due to higher risk of insolvency.
CONVERTIBLE BONDS
Fixed-income debt security that yields interest payments but can be converted into common stock or equity shares.
CALLABLE BONDS
Issuer reserves the right to return the investor’s principal and stop interest payments before the bond’s maturity.
INVESTMENT GRADE BONDS
Bonds that credit rating agencies give higher credit ratings and are said to have lower risk of default.
JUNK BOND
HIGH YIELD BOND
Bonds issued by companies with no investment-grade credit rating in which the interest payments are higher than average corporate bonds.
PORTFOLIO
Group of assets that are managed by a trader or trading company.
TRADING PORTFOLIO
Consists of different investment vehicles, each geared towards a different investment strategy.
MUTUAL FUND OF BONDS
BOND FUNDS
Fund that invests solely on bonds that do not have a maturity date for the repayment of the principal.
PORTFOLIO LOAN
Mortgage loan originated by a bank and held in the bank’s portfolio for the life of the loan.
DURATION
Time measure of a bonds or fixed-income portfolio’s price sensitivity to interest rate changes.
3 MAIN CONCLUSIONS ABOUT DURATION
- Gives better maturity of bond/loan/CF
- Very good approximation of interest rate risk
- Time in which IRR = Effective Rate of a bond
CONVEXITY
Measure of the curvature in the relationship b/w bond prices and bond yields.
NEGATIVE CONVEXITY
When duration and yield increases at the same time.
