Chapter 2&10 (Bonds) Flashcards
Bankers’ Acceptance
An order to a bank by a customer to pay a sum of money at a future date.
Call Option
The right to buy an asset at a specified exercise price on or before a specified expiration date.
Certificate of Deposit
A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.
Commercial Paper
Short-term unsecured debt issued by large corporations.
Common Stocks
Ownership shares in a publicly held corporation. Shareholders have voting rights and may receive dividends.
Corporate Bonds
Long-term debt issued by private corporations typically paying semiannual coupons and returning the face value of the bond at maturity.
Derivative Asset
A security with a payoff that depends on the prices of other securities.
Equally Weighted Index
An index computed from a simple average of returns.
Eurodollars
Dollar-denominated deposits at foreign banks or foreign branches of American banks.
Federal Funds
Funds in the accounts of commercial banks at the Federal Reserve Bank.
Futures Contract
Obliges traders to purchase or sell an asset at an agreed-upon price at a specified future date.
London Interbank Offer Rate (LIBOR)
Lending rate among banks in the London market.
Market Value-Weighted Index
Index return equals the weighted average of the returns of each component security, with weights proportional to outstanding market value.
Money Markets
Include short-term, highly liquid, and relatively low-risk debt instruments.
Municipal Bonds
Tax-exempt bonds issued by state and local governments.
Preferred Stock
Nonvoting shares in a corporation, usually paying a fixed stream of dividends.
Price-Weighted Average
An average computed by adding the prices of the stocks and dividing by a “divisor.”
Put Option
The right to sell an asset at a specified exercise price on or before a specified expiration date.
Repurchase Agreements (Repos)
Short-term sales of government securities with an agreement to repurchase the securities at a higher price.
Treasury Bills
Short-term government securities issued at a discount from face value and returning the face amount at maturity.
Treasury Notes or Bonds
Debt obligations of the federal government with original maturities of one year or more.
What determines the price of a bond?
Present value of the promised payments
What characterizes a bonds yield to maturity? 2
- discount rate
- average rate of return
A junk bond is characterized based on …
Credit Rating
when will a firm call its bonds?
When interest rates fall
What should a zero coupon bond experience over its life?
Appreciation.
Bond Characteristics. 2
- Fixed income investments
- Security that obligates issuer to make fixed payments to holders over time
- periodical interest usually paid semiannually
Benefits of a bond in a Portfolio. 6
- Diversification
- Weak correlation with stock.
- lower stand. Dev. than equities/ fewer losses.
- Dividend Clientele
- Higher return than CD’s or Savings Accounts.
- Some have Tax Advantages
Face (Par) Value
Principle of Bond
Coupon Payment
Interest Payment
Coupon Rate
interest payment per dollar of par value
Maturity
When you receive the principle
Price of Bond
- How much you pay fo da bond
- present value of coupon payments and principles
Yield to Maturity
- Actual Return
- the discount rate
Credit Rating
the default risk of a bond
How does a rise in market interest rate effect bond prices?
Prices of Bonds fall, opposite correlation to market interest rate
What is the primary source of bond market risk?
Interest Rate Fluctuations
Par Bond
when price= face valueor coupon rate = yield to maturity
Premium Bond
when price> face valueor coupon rate> face value
Discount Bond
when price< face value or coupon rate< face value
Who establishes Credit Ratings?
Moody’s, S&P, Fitch
What classifies as an investment grade bond?
S&P- BBB or aboveMoody’s - Baa or above
What classifies as a junk bond
S&P - BB or lowerMoody’s - Ba or lower OR unrated :)
Corporate bonds
- issued by corporations
- call feature: allows issuer to redeem bond prior to maturity
- convertible feature: holders have the option of converting to stock
Municipal Bonds
-issued by municipalities - nontaxable at the federal, state, & local level if you live in the state.
Risk of Bonds. 5
- credit risk
- interest rate risk
- exchange rate risk (if foreign bonds)
- inflation risk
- call risk (firm will buy back bond)
Types of Bonds. 3
- treasury bonds
- corporate bonds
- municipal bonds
What is invoice price
Flat price + Accrued interest
Expectations Hypothesis
yields to maturity determined solely by expectations of future short-term interest rates or inflation rate
Liquidity Hypothesis
Investors demand a risk premium on long-term bonds
Interest rate sensitivity
- Bond prices and yields are inversely related
- Long-term bond prices more sensitive to interest rate changes than short-term bonds
- as maturity increases, sensitivity of bond prices to changes in yields increases at decreasing rate
- low coupon bonds are more sensitive to interest rates
What is duration?
How sensitive bonds are to interest risk
Zero coupon bond
duration=time to maturity
Immunization
-Strategy to shield net worth from interest rate movement -two of setting interest rate risk; price risk and reinvestment rate-match the duration with the investment horizon
Bond Swaps
- managing bond portfolio by selling some bonds and buying others
- benefits include tax treatment (loss now gains later), yield, and maturity structure
Bullets
Mainly use zero-coupon bond-cash flow matching-generate cash outflow in a certain date
Barbells
-owning both short and long-term bond
Laddered Strategy
- Cash management: relatively liquid
- reduce interest risk (hold bonds until maturity)
Convexity
-curvature of price yield relationship of bond
How are Stocks Weighted? 3
- Price Weighted (DJIA)
- Market Value Weighted (S&P 500, NASDAQ)
- Equally Weighted
Value Weighting Implications. 2
- larger stocks dominate index
- Performance characteristics reflect size
Equal/Price Weighting Implications. 3
- Smaller Stocks are more important
- Tend to be more volatile, Higher Beta
- Higher expected return
