Chapter 14: Bond Markets Flashcards
“bond”
An alternative term for a fixed-interest or index-linked security.
Bonds are described by (2)
- type of organisation issuing the security, ex. government, local authority, corporate
- nature of the bond - fixed interest/index-linked
“gilts”
UK government bonds
Fixed-interest / conventional bond
Gives an income stream and final redemption proceeds that are fixed in monetary terms
Index-linked bond
Gives an income stream and final redemption proceeds that are linked to an inflation index.
3 Types of bond markets
- government bonds
- corporate bonds
- overseas government and corporate bonds
7 Investment and risk characteristics of conventional government bonds.
- very good security (if politically stable)
- yield (GRY) is fixed in nominal terms
- lower expected returns than equities over the long term
- market values can be volatile, especially for longer-term bonds
- mixture of terms’ short, medium, long, undated
- low dealing expenses
- highly marketable
3 Types of corporate bonds
- Debentures
- Unsecured loan stock
- Subordinated debt
Risk & investment characteristics of corporate bonds
Less: - secure - marketable - liquid than government bonds. Consequently, they generally offer a higher yield to investors.
4 Theories put forward to explain the shape of the yield curve
- Expectations theory
- Liquidity preference theory
- Inflation risk premium theory
- Market segmentation theory
Expectations theory
Yield reflect future short-term interest rates and inflation
Liquidity preference theory
Investors require an additional yield on less liquid (longer-term) bonds.
Inflation risk premium theory
Investors require an additional yield on longer-term conventional bonds to compensate for the risk of inflation being higher than anticipated.
Market segmentation theory
Yields at each term are determined by supply and demand at that term.
Demand comes principally from institutional investors trying to match liabilities.
Real yield curve
Plot of real gross redemption yields on index-linked bonds against term to maturity.