Bonds Overview Flashcards
Describe basic characteristics and types of fixed income instruments Explain the risk involved in investing in fixed income securities Understand how derivatives are used to hedge interest rate and credit risk Locate fixed income reports on the FactSet Workstation
What is the name of the legal document that outlines the T&Cs of the bond (principal amount, coupon rate,…)?
Indenture
What is the coupon rate, and how is it quoted?
The coupon rate is the interest paid by the issuer to the bondholder. It is expressed as a percentage of the principal value, and it is quoted annually.
A bond has a principal amount of $1,000 and a coupon rate of 10% with a quarterly payment frequency. What is the interest received by the bondholder every quarter?
10% / 4 = 2.5%
$1,000 * 2.5% = $25
What are two reasons that cause investors to chose bonds over equities?
- Everything else equal, bonds are less riskier than equities (they are paid before equity holders after liquidating assets)
- The performance of bonds is driven by market factors (and less so by company-specific factors); therefore, there is less price volatility in the fixed income market.
Name three of the major types of bonds in the market.
- Treasury
- Corporate
- MBS
True or false? Zero-coupon bonds typically trade at a discount.
True. Investors will typically pay less than the principal amount for the zero-coupon bond to generate some positive yield.
What are two of the key risks that bondholders face and how can investors hedge against those risks?
- Interest rate risk. Interest and bond prices have an inverse relationship. There is potential for the investor to lose out if the interest rate moves against them unfavourably. This risk can be hedged using an interest rate swap.
- Credit risk. No matter how safe, there is always a chance that the counterparty might not satisfy their debt obligations or at least their ability to satisfy them deteriorates (a change in their credit rating). Investors can hedge against this type of risk through a credit default swap.
Where on FactSet can we locate fixed income reports?
The Company/Security tab. All we need is the name of the company, the coupon rate, and the maturity date to search for a bond (utilise FactSet Search)!
