Bond pricing Flashcards
Because bonds are debt, issuers are … and holders are …
Because bonds are debt, issuers are debtors and holders are creditors
What is the indenture and what does it give?
Indenture is the contract between the issuer and the bondholder that details the coupon rate, maturity date, and par value.
What is the par value and it’s common value in the UK and US?
The par value is the value repaid at maturity, and is typically £100 in the UK and $1000 in the US.
What are callable bonds?
Callable bonds are bonds that can be repurchased at any time before the maturity date
What are convertible bonds?
Convertible bonds are bond that the holder can exchange for shares in the company at any time
What are puttable bonds?
Puttable bonds give the bondholder the option to retire or extend the bond
What are floating rate bonds?
Floating rate bonds are bonds with an adjustable coupon rate
What type of relationship do bond prices and yields have?
Bond prices and yields have an inverse relationship.
What is the link between the length of maturity and the sensitivity of the bond’s price to changes in interest rates?
The longer the length of maturity of a bond, the higher the sensitivity of the bond’s price to changes in interest rates
What is the formula for present value factor?
The formula for present value factor is:
1/(1+r)^T
What is the Yield to maturity?
The yield to maturity is the yield required for the future value of all future payments to be equal to the current bond price.
What does YTM assume?
YTM assumes that all bond coupons can be reinvested at the YTM rate
What is the current yield?
The current yield is the bond’s coupon payment as a function of it’s current price, which may be different from it’s par value.
For which priced bond is c > current yield > YTM?
For bonds selling at a premium, c > current yield > YTM
What is holding period return?
Holding period return is the yield on an investment over a certain time period, for example a quarter.
What are 2 bond ratings companies?
Two bond ratings companies are Moody’s and Standard & poor
What rating are Investment grade or junk bonds?
Investment grade bonds are BBB or above, and bonds below this rating are considered “junk” bonds
What information can be implied from the yield curve?
The yield curve can reveal expectations of future short term interest rates
What relationship does the yield curve display?
The yield curve displays the relationship between the maturity of a bond and a given interest rate
What does an upward sloping yield curve give evidence of?
An upward sloping demand curve is evidence that short-term rates are going to be higher next year
Why do investors require a risk premium to hold a long-term bond?
Investors require a risk premium to hold a long term bond because they are more sensitive to interest rate movements and carry a higher risk
What does this liquidity premium compensate short-term investors for?
This liquidity premium compensates short-term investors for assuming long term risk
What does the segmented market theory come from?
Segmented market theory comes from the observation that many investors and debt issuers seem to have strong preference for debt of a certain maturity
What is a reason/example for segmented markets?
An example/reason for segmented markets is a company investing in warehouses or infrastructure, who need a more long-term debt structure.
What does market segmentation theory argue?
Market segmentation theory argues that investors are sufficiently risk averse and that they operate only in their desired maturity spectrum
Under expectations theory, what is observed long term rates a function of?
Under expectations theory, the observed long term rates are a function of both today’s short term rates and expected future short term rates
Under expectations theory, long term and short term securities are perfect …
Under expectations theory, long and short term securities are perfect substitutes
Premium theory states long term bonds are more …
Liquidity premium theory states long term bonds are more risky
Premium theory says investors will demand what for what? Why does premium theory state the yield curve has an upward bias?
Premium theory states that investors will demand a higher risk premium for taking on more risk/buying a longer maturity bond. It states that the yield curve has an upward bias because of this
What’s the difference between forward rates and expected future short-term rates?
The difference between forward rates and expected future short term rates are that forward rates have liquidity premium built in
What happens to the yield curve as we move to longer maturities?
As we move towards longer dated maturities, the yield curve rises/slopes upwards.
What 3 reasons mean a longer maturity result in the inclusion of a new higher forward rate?
- Markets are segmented
- Higher expectations for forward rates
- Liquidity premium
