Bonds and their investments Flashcards
What is a bond?
A promise to pay a pre-specified amount in the future.
What do bonds consist of?
: Coupons (interest payments) and principal (face value).
What are the types of bond interest payments?
- Fixed-rate bonds – Fixed interest payments.
- Floating-rate bonds – Interest tied to current rates.
What are the types of bond security?
- Secured bonds – Backed by collateral.
- Unsecured bonds – No collateral backing.
What are the different bond maturities?
- Short-term
- Medium-term
- Long-term
Who are the main issuers of bonds?
- Central governments – Treasury bills, notes, bonds.
- Local governments.
- Government agencies.
- Corporations – Corporate bonds, convertible bonds, mortgage-backed bonds.
- International governments & corporations.
- Innovative bonds
How is a bond valued?
By discounting its expected cash flows (coupon payments + principal) using an appropriate discount rate.
Bond Value Formula?
Present value of coupons + Present value of par value.
What factors increase bond price (if all else is equal)?
- Higher coupon rate.
- Longer time to maturity.
- Lower interest rates.
How are bond price and yield related?
Inversely related – As yields rise, bond prices fall.
What happens when market yields rise above a bond’s coupon rate?
The bond price falls, allowing new investors to earn capital appreciation.
What does it mean if a bond is selling at a discount or premium?
Discount – Price is below par value.
* Premium – Price is above par value.
How does a bond’s price change with yield changes?
- Longer maturity bonds are more sensitive to yield changes.
- Price sensitivity increases with longer cash flow periods
Why is maturity a poor measure of price sensitivity?
Because duration is a better measure
What is Macaulay Duration (MD)?
The weighted average time to receive a bond’s cash flows.
What is Modified Duration?
Measures percentage change in bond price due to a small yield change.
What is bond portfolio duration?
Measures the interest rate sensitivity of an entire bond portfolio.
How can bond investors manage interest rate risk?
Through immunization, a passive strategy that matches interest rate exposure of assets and liabilities.
What do active bond managers do?
Seek profits by predicting interest rate and yield spread movements.
What factors influence active bond strategies?
- Changes in interest rate levels.
- Changes in yield curve shape.
- Changes in yield spreads.
What is “Riding the Yield Curve”?
Buying longer-term bonds to earn higher returns, then selling as yields decrease over time.
What is Fixed-Income Arbitrage?
Exploiting price differences between fixed-income securities.
What are On-the-Run Treasuries?
Newly issued bonds, highly liquid, easy to trade.
What are Off-the-Run Treasuries?
Older bonds, less liquid, often cheaper.
