CFA Level 2 Flashcards - 4
Extendible bond
Bond with an embedded option that gives the bondholder the right to keep the bond for a number of years after maturity, possibly with a different coupon.
Floored floater
Floating-rate bond with a floor provision that prevents the coupon rate from decreasing below a specified minimum rate. It protects the investor against declining interest rates.
Forced conversion
For a convertible bond, when the issuer calls the bond and forces bondholders to convert their bonds into shares, which typically happens when the underlying share price increases above the conversion price.
Key rate durations
Sensitivity of a bond’s price to changes in specific maturities on the benchmark yield curve. Also called partial durations
Market conversion premium per share
For a convertible bond, the difference between the market conversion price and the underlying share price, which allows investors to identify the premium or discount payable when buying a convertible bond rather than the underlying common stock.
Market conversion premium ratio
For a convertible bond, the market conversion premium per share expressed as a percentage of the current market price of the shares.
One-sided durations
Effective durations when interest rates go up or down, which are better at capturing the interest rate sensitivity of bonds with embedded options that do not react symmetrically to positive and negative changes in interest rates of the same magnitude
Option-adjusted spread
(OAS) Constant spread that, when added to all the one-period forward rates on the interest rate tree, makes the arbitrage-free value of the bond equal to its market price.
Protection period
Period during which a bond’s issuer cannot call the bond.
Putable bond
Bond that includes an embedded put option, which gives the bondholder the right to put back the bonds to the issuer prior to maturity, typically when interest rates have risen and higher-yielding bonds are available.
Sinking fund bond
A bond that requires the issuer to set aside funds over time to retire the bond issue, thus reducing credit risk
Straight bond
An underlying option-free bond with a specified issuer, issue date, maturity date, principal amount and repayment structure, coupon rate and payment structure, and currency denomination.
Covered bonds
A senior debt obligation of a financial institution that gives recourse to the originator/issuer and a predetermined underlying collateral pool.
Credit valuation adjustment
The value of the credit risk of a bond in present value terms.
Expected exposure
The projected amount of money an investor could lose if an event of default occurs, before factoring in possible recovery.
Loss given default
The amount that will be lost if a default occurs
Probability of default
The likelihood that a borrower defaults or fails to meet its obligation to make full and timely payments of principal and interest.
Recovery rate
The percentage of the loss recovered.
Bankruptcy
A declaration provided for by a country’s laws that typically involves the establishment of a legal procedure that forces creditors to defer their claims
Basis trade
A trade based on the pricing of credit in the bond market versus the price of the same credit in the CDS market. To execute a basis trade, go long the “underpriced” credit and short the “overpriced” credit. A profit is realized as the implied credit prices converge
CDS spread
A periodic premium paid by the buyer to the seller that serves as a return over a market reference rate required to protect against credit risk.
Cash settlement
A procedure used in certain derivative transactions that specifies that the long and short parties settle the derivative’s difference in value between them by making a cash payment.
Cheapest-to-deliver
The debt instrument that can be purchased and delivered at the lowest cost yet has the same seniority as the reference obligation.
Credit correlation
The correlation of credit (or default) risks of the underlying single-name CDS contained in an index CDS.