Bonds and the Bond Market, Deck 1

Question 1

Factors influencing a bond’s yield

Answer 1

Growth expectations + inflation expectations + term premium

Growth expectations informed by presence or absence of cyclical growth (fiscal stimulus, abundant credit, earnings cycle) +
secular growth (demographics, productivity)

Question 2

Term premium

Answer 2

the compensation investors demand to take on long-dated interest rate risk rather than just owning and rolling T-bills.

Question 3

PV

Answer 3

Present Value

Question 4

Formular for calculating PB (Price of Bond): Explain variables

Answer 4

Coupons = cash flows, i = inflation rate

Question 5

10-year Treasury yield

Answer 5

One can think of it as a “strip” of all the future overnight interest rates for the next 10 years discounted to today.
(A strip bond is a debt obligation whose principal and coupon payments are removed (or stripped) by investment firms or dealers and sold separately to investors. An investor who buys the separated principal from the bond, known as the residue, receives an amount equal to the face value of the bond when it matures.)

Question 6

swap

Answer 6

an agreement between two counterparties to exchange a set of fixed cash flows depending on a fixed interest rate with a set of floating cash flows depending on future variable interest rates.

Most swaps are entered into when PV=0 at inception such that the present value (PV) of the fixed leg = the PV of the floating leg.

Question 7

N (abbreviation)

Answer 7

Notional

Answer 8

fixed rate