Bonds Flashcards
Coupon Rate
fixed rate of the bond that pays a percentage of the bond’s par value annually.
Yield Curve
a graph representing the term structure of interest rates, with the term to maturity on the horizontal axis and the yield on the vertical axis. It changes as market expectations of interest rates change.
Yield to Maturity
the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond.
Par Value
The amount paid at maturity; usually $1000.
Duration/Maturity
How long, from issuance, the bond will pay coupons and finally pay par value to the bond owner.
Credit Rating Indexes
Standard & Poor, Moody, Fitch, and DBRS (Bloomberg)
Two largest bond markets and their fraction of the market?
Treasuries: 35%
Corporates: 25%
Three kinds of Bonds and what that means about their price.
Premium: price > $1000
At Par: price = $1000
Discount: price < $1000
Relationship of Bond Prices to Interest Rates?
Inverse.
Only “riskless” investment?
Treasuries.
Three kinds of Treasuries and their durations.
T-bill: less than a year.
T-note: 2,3,5 or 10 years.
T-Bond: 10-30 years.
Political Risk
Debt ceiling standoff.
Interest Rate Risk.
risk that interest rates will hike and slash bond prices; present in all bonds.
Inflation Risk
closely tied to interest rate risk; risk that inflation and high interest rates will slash bond price.
Reinvestment Risk
risk that coupons reinvested will fall; this risk is greater during longer holding periods.
Call Risk
risk of bond being called before maturity and you miss out on possible gains.
Liquidity Risk
risk that your bond does not trade often enough and therefore is not very liquid.
Risk Risk
not knowing where the risk is.
Benefits to Treasuries
- Highly liquid
- Enormous trading volume
- Narrow Spreads
- Efficient
- Highly Regulated
- Noncallable
- bought directly from government
Short Term Floating Rate Notes (FRNs)
pay quarterly and reset interest rate after each payment; fairly new.
Treasury Inflation Protected Securities (TIPS)
- principal value rises as inflation rises
- coupon rate is fixed and not changing with inflation
- move a lot with interest rate and inflation rate movements
Causes of Inflation
- Commodity Pricing
- Medicare Expense
- Tuition
- Government Spending
- Wage Inflation
- Government Regulation
STRIPS
issued by investment banking firms. Strip cash flows from each payment and the principal. Good for parents funding college. Good for staggered payments.
Agency Bonds and Government Sponsored Enterprise.
assumed that there is guarantee cus they think gov will back them if the enterprise goes upside down. Have pretty good credit (in the As).
Settlement Date
establishes legal transfer of ownership from seller to buyer. This is not when the actual sale takes place. Usually happens the day after the sale.
Current Yield
The yield in the current period/year. Coupon PMT / price paid for bond.
Current Yield vs. Yield to Maturity
Current Yield does not factor in TVM while YTM does.
How many days after transaction is the settlement day normally on the secondary bond market?
just one day.
What is the most recent issue of certain bonds called?
the CURRENT ISSUE or the ON THE RUN issue.
What does a Treasury quoted at “91-19” mean?
It means the treasury sells at $91 + $19/32 per $100.
Upon sale, the former bond owner has held the bond for 90 days. The $1000 bond has a coupon rate of 5%. How much accrued interest must be paid to the former owner for the bond?
$12.5
Three types of Corporates by sector?
Utilities, Financials, and Industrials
Convertible Bond
A corporate bond that can be converted into stock; most are callable.
If the conversion ratio for a convertible corporate is 40, what is the value of each share upon issuance?
$25; $1000/40
Junk Bonds
Corporates issued by young or failing companies. They are deemed ‘junk’ because their credit ratings are low. These bonds have high yields.
Only two companies with AAA credit ratings?
Microsoft and J&J.
Covenants
promises of issuer and rights of buyers are listed in contract known as bond indentures.
Can Municipals default on their bonds issued?
Yes, but it’s rare.
Three Types of Muni Bonds?
- Tax Backed Debt/General Obligation (GO) Bonds
- Revenue Bonds: backed revenue from a specific project.
- Asset Backed Bonds/Structured Bonds: backed by expected assets.
Continuous Compounding Formula
FV = PV * e^(rt)
Call Provision
covenant that allows issuer to make buyer/owner sell the bond back to issuer at a price within a certain amount of time after issuance; brilliant, protects corporation, and increases the coupon rate of the bond.
4 types of Corporate Bonds by Security; what is the waterfall effect?
- Mortgages Bonds: backed by land and buildings.
- Equipment Trust Bonds: backed by assets in the buildings.
- Debentures: backed by trust.
- Subordinate Debentures: also backed by trust but lower priority for repayment than debentures.
Waterfall Effect: as you go down, the less likely that bond is getting paid back because of priority and the asset backing the bond.
Investment Grade
AAA-BBB
Speculative Grade
less than BBB
Call Premium
the extra coupon and amount paid when a bond is called by issuer because the bond has a call provision.
