Bonds

Question 1

Why does the state use bonds and not borrow from the bank?

Answer 1

Bonds feature a secondary market for investors, meaning higher liquidity. The provision of higher liquidity enables investors to accept a lower interest rate.

Question 2

What do we need to know of bonds?

Answer 2

Their specification and valuation, the types of bond market securities and other exotic bonds.

Question 3

What is a Bond?

Answer 3

A promise to make periodic coupon payments and to repay principal at maturity.

Question 4

How is the principal and interest of the Bond paid?

Answer 4

Principal is paid at maturity.

Interest is paid on regular intervals at a fraction of the annual coupon rate depending on the frequency of the payments.

Question 5

Who are Bonds issued by?

Answer 5

Corporations and government units

Question 6

What are the 6 parts of the Bond quote?

Answer 6

RATE
MATURITY
BID
ASK
CHG
ASK YLD

Question 7

What is ASK YLD?

Answer 7

The Yield To Maturity (Discount Rate) if purchased at ASK price

Question 8

What is RATE?

Answer 8

The coupon rate as a percentage of the face value.

Question 9

What is MATURITY?

Answer 9

The date of maturity (dd/mm/yyyy) of the bond.

Question 10

What is CHG?

Answer 10

The change from the prior closing price in 32nds.

Question 11

What is BID?

Answer 11

The price at which the trader will buy the bond (the cheaper value)

Question 12

What is ASK?

Answer 12

The price at which the trader will sell the bond (the more expensive value)

Question 13

How do Bonds compare with Equities?

Answer 13

For Issuers: Coupon payments are compulsory (not in Equity)

For Investors: State bonds offer less return but also less risk (opposite in Equity). The exception is some Corporate Bonds and Emerging market State Bonds.

Question 14

Coupon payments are constant, so what are Yields?

Answer 14

The Yield is the value derived when comparing the future cash flows to the current market price of the Bond.

The Yield is also used to compare different bonds.

Question 15

What is Yield To Maturity?

Answer 15

The price of a Bond is determined by the present value of the future cash flows of the bond. (1 + r) is the discount factor used. R in this case the YTM.

Thus, if the yield rises, then the price of the bond goes down.

Question 16

What is the relationship between YTM and IRR?

Answer 16

They are both the same value.

Question 17

What are the most common bond terminologies?

Answer 17

Bond trading above par value: Premium

Bonds trading below par value: Discount

Bond prices approaching par as they near maturity: Pull to Par

Question 18

What is the process for Bond purchases between interest payment dates?

Answer 18

Bond may be sold with accrued interest accounted for: Full price

Bond may be sold without accrued interest: Clean price

Question 19

Which Bonds are of the lowest risk?

Answer 19

G7 Government bonds have very low default risk (apart from Italy).

Corporate and emerging market bonds are much higher.

Question 20

What risks does an investor take when he buys a Bond?

Answer 20

Inflation may reduce the purchasing power of future repayments.

Market prices may fluctuate.

Re-investment risk attached to the coupon payments

Question 21

Who does the credit rating of the Bonds?

Answer 21

Moody’s, S & P’s, Fitch

Bond’s are rated according to perceived default risk.

Question 22

What are Mortgage bonds?

Answer 22

US mortgages which are “securitized” are packaged and sold as publicly traded bonds. This makes debt more liquid and attractive to investors.

Question 23

What are Eurobonds?

Answer 23

Long-term bonds sold outside the country of the currency in which they are denominated. e.g. Eurobonds sold in China.

Question 24

What are Foreign Bonds?

Answer 24

Bonds issued outside the home country and denominated in the host country’s currency. e.g. “Samurai bonds” are dollar denominated bonds issued by Japanese borrowers in the US.

Question 25

What affects the Corporate Bond Yields?

Answer 25

Apart from interest rates, the economic conditions, investors risk appetites and the liquidity factor.