Bonds Flashcards
who issues bonds mainly
corporates and government
who helps corporates issue bonds
institutions eg investment banks
what is the secondary market for bonds
the market where securities that have been issued previously are traded
what does OTC stand for
over the counter
stocks mostly trade on exchanges
where do bonds mostly trade
over the counter
(from buyer to seller)
in what ways is the bond market different from the stock market
- most companies just issue one type of share at a common price where as lots of bonds can be issued at all different prices and maturity dates
- average size of a bond trade tends to be far larger than an equity trade
- bonds trade far less frequently so there is much less liquidity in bonds
which are the most liquid type of bonds
government bonds
do retail investors usually buy bonds
no far too complex
minimum trading price also very high so most often done by institutional investors
is the issuer of the bond involved in the secondary market trading of the bond
no
what is refinancing
when a company issues a new bond to pay off old bond debt
what is a refinancing cliff
one huge outstanding bond that occurs at one point in time and needs to be paid off
what is a better approach than having a refinancing cliff
a range of long and short term bonds so the refinancing risk is spread over time
what are the sectors of the bond market
- treasury
2, agency - municipal
- corporate
- asset backed
- mortgage
what is a treasury bond
securities issued by the US government
what is an agency bond
securities issued federally related to institutions and government sponsored enterprises
what is a municipal bond
securities issued by state and local government bonds
what is a corporate bond
securities issued by corporations
what is an asset backed bond
securities backed by pool of assets
what does a bond price refer to
the price it is trading for on the secondary market
what two elements about the bond are fixed
maturity date
coupon
what type of relationship do the bond price and yield have
inverse
what is the name of the price the bond is issued at
par
when the bond is retraded, we state it in terms of its
yield
if a bond is trading above par eg 110 what does this mean
the coupon must be too high
if a bond is trading below par eg 90 what does this mean
the coupon must be too low
if a bond is trading at par what does this make the coupon equal to
yield to maturity
why might the coupon of a bond be considered too high or too low
at the date of issue, the coupon is correct for that current climate
things change though such as inflation and interest rates and this can determine if the bond coupon is too high or too low
what are the main risk factors for the bond (things that can change the yield)
- interest rates
- expected inflation
- credit/default risk
- liquidity
what is the risk free rate in the eurozone
where the German government issue at
how does an increase in interest rates effect bonds trading in the secondary market
if interest rates are higher then the existing bonds are less attractive as the nominal value of their coupons is lower
how does increased inflation effect bonds already trading in the secondary market
makes less attractive because the nominal value of coupon is lower
how do equities tend to perform in high inflationary periods
they do fine as they have floating prices that they can adjust for inflation
how does increased risk effect bonds already trading on the market
riskier investment so will be below par value
eg in 2011 investors refuse to lend to Irish government
is more or less liquidity more attractive for bonds
more
two ways to measure interest rate risk
duration
convexity
what is duration (for measuring interest rate risk)
the sensitivity of a bond price to change in interest rate
how is duration usually stated (interest rate risk)
for every 1% change in interest rate, how much will the price of the bond fall
what else will effect the duration risk
maturity date of the bond
what is convexity
relationship between bond price and interest rate is not linear, it is curved
how curved = convexity
how can credit risk be measured
credit spread
credit default swaps
what is the credit spread of a return
the part that is attributed to its default risk
what is a credit default swap
derivative product that replicates bond exposure
which market is more liquid
- credit default swap
- bond
credit default swap
which bonds are not exposed to inflationary risk
floating rate bonds
what is a floating rate bonds
a bond which a coupon that is tied to inflation
what is the inflation linked bond in the US
TIPS (treasury inflation linked bond)
what is liquidity risk
the ease at which an issue can be sold at or near its value
how to measure liquidity risk
the size of the spread between the bid price and asking price
the bigger the spread, the more liquidity risk
why would investors buy bonds with negative yields
- bond prices may fall but overall they are a much safer investment product than equities, the alternative
- pension and insurance funds are long term and may have minimum allocation targets for bonds
- paying money to governments is profitable if a year later the prices go even more negative, can be sold for a profit
- required to hold them as part of a passive funds, as other bonds mature and roll off, they are replaced with new bonds
what is call provision
grants the issuer the right to repay the debt, fully or partially, before the scheduled maturity date
why would issuer use callable bonds (call provision)
option to get cheaper borrowing
what is a put provision
the bondholder has the right to ask to be repaid after a number of years
why would an investor want a putable bond (pull provision)
eg if issuers credit risk has worsened they can ask to be paid now to avoid risk of not being paid later
what is a convertible bond
the bondholder can opt to change the bond into shares
why might an investor want a convertible bond
want to play it safe with a bond but if things go well with the company, you will benefit more from equitiy
what is a currency bond option
the bondholder can choose the currency in which they would like to be paid
(coupon and principal)
who pays for the embedded option
whoever benefits from the option
rests with lender = higher coupon
rests with borrower - lower coupon
how much percent of new bond issues are green and social bonds
5-10%
is there a legal binding for proceeds from green bonds to be ringfenced
no
more of a statement of intent
examples of spending from social bonds
education, health, social housing, reducing inequality
what issues exist with green bonds
issues of reporting, accountability and standardisation
expected to become more standardised over time
what is a greenium
there is a greater demand for green bonds
but not so much supply
so willing to pay greenium
why are pension funds tax free
government trying to incentivise us to smooth consumption
what is the time frame of a money market
less than 1 year
what is the time frame of a cpital market
greater than 1 year
what is a zero coupon bond
does not make coupon payments
at what price do zero coupon bonds always sell at
discount
what is the compenstation for a zero coupon bond
the difference between the initial price and the face value ie the payout at the end
what is the YTM
the discount rate that sets the present value of the promised bond payments equal to the current market price of the bond
what is bond pirce
present value of all the cash flows generated by the bond
ie the coupons and face value discounted at the required rate of return
what does it mean if the bond is selling at a discount
selling for less than the face value
what does it mean if the bond is selling at par valye
selling at face value
what does it mean if the bond is selling at a premium
selling for greater than the face value
what does an investor earn as a return when the bond trades at a discount
coupon rate < yield to maturity
return from coupons
face value that exceeds the price paid for the bond
what does the investor earn as return when the bond trades at a premium
coupon rate > yield to maturity
return from coupons
face value less than price paid for the bond
closer to the time of maturity of the bond, what price does the bond move towards
par value, face value
each time a coupon is paid, what does the price of the bond drop by
coupon amount
why are shorter term bonds less risky
discounted over a shorter period, present values are less dramatically affected by interest rates
what does a yield curve plot
yields of bonds that have equal quality but differing maturity rates
what does the slope of a yield curve tell us
an idea of future interest rate changes and economic activity
what is the normal slope for a yield curve
gentle upward sloping (normal rates of growth expected)
when is a steep upward sloping yield curve usually found
when bond holders think economy will improve quickly in the future
just at the beginning of economic expansion, at the end of recession
what does an inverted yield curve mean
investors trying to get in and lock rates before they fall even further
what is a prime bond rating
AAA
upper medium grade bond rating
A
medium grade bond rating
BBB
what is the conversion ratio of a convertible bond
how many shares can be converted from each bond
