Bond Markets

Question 1

TIME VALUE OF MONEY

Answer 1

Value that an amount of money has at different periods of time.

Question 2

NET PRESENT VALUE (NPV)

Answer 2

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.

Question 3

DISCOUNTING

Answer 3

Process of converting a value received in the future to an equivalent value received immediately.

Question 4

PERPETUITY

Answer 4

Stream of CF’s received continuously for an indefinite amount of time. (annuities that last forever)

Question 5

ANNUITY

Answer 5

Series of payments received over equal time intervals.

Question 6

BONDS

Answer 6

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.

Question 7

RELATIONSHIP B/W RATES AND PRICES

Answer 7

In order to obtain the price of fixed-income instruments, you need to get the PV of payments discounted at the proper interest rate.

Question 8

INTEREST RATE YIELD CURVE

Answer 8

Represents the relationship b/w market interest rates and the remaining time to maturity of debt securities.

Question 9

INTERNAL RATE OF RETURN (IRR)

Answer 9

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.

Question 10

EFFECTIVE YIELD

Answer 10

Return on a bond that has its coupons reinvested at the same rate by the bondholder.

Question 11

IRR = Effective Yield, when?

Answer 11

1. Bond is held until maturity or bond is sold and you get the IRR during the life of the bond.
2. You can reinvest the coupons at the IRR

Question 12

CORPORATE BONDS

Answer 12

Bonds issued by corporations that offer a higher yield than government bonds due to higher risk of insolvency.

Question 13

CONVERTIBLE BONDS

Answer 13

Fixed-income debt security that yields interest payments but can be converted into common stock or equity shares.

Question 14

CALLABLE BONDS

Answer 14

Issuer reserves the right to return the investor’s principal and stop interest payments before the bond’s maturity.

Question 15

INVESTMENT GRADE BONDS

Answer 15

Bonds that credit rating agencies give higher credit ratings and are said to have lower risk of default.

Question 16

JUNK BOND

HIGH YIELD BOND

Answer 16

Bonds issued by companies with no investment-grade credit rating in which the interest payments are higher than average corporate bonds.

Question 17

PORTFOLIO

Answer 17

Group of assets that are managed by a trader or trading company.

Question 18

TRADING PORTFOLIO

Answer 18

Consists of different investment vehicles, each geared towards a different investment strategy.

Question 19

MUTUAL FUND OF BONDS

BOND FUNDS

Answer 19

Fund that invests solely on bonds that do not have a maturity date for the repayment of the principal.

Question 20

PORTFOLIO LOAN

Answer 20

Mortgage loan originated by a bank and held in the bank’s portfolio for the life of the loan.

Question 21

DURATION

Answer 21

Time measure of a bonds or fixed-income portfolio’s price sensitivity to interest rate changes.

Question 22

3 MAIN CONCLUSIONS ABOUT DURATION

Answer 22

1. Gives better maturity of bond/loan/CF
2. Very good approximation of interest rate risk
3. Time in which IRR = Effective Rate of a bond

Question 23

CONVEXITY

Answer 23

Measure of the curvature in the relationship b/w bond prices and bond yields.

Question 24

NEGATIVE CONVEXITY

Answer 24

When duration and yield increases at the same time.

Question 25

POSITIVE CONVEXITY

Answer 25

When duration increases but yield decreases.