Chapter 2 - Asset Classes - Debt Flashcards

Question

Inflation relationship with the yield curve

Answer 1

'Nominal yields' are taken from conventional debt instruments and anticipate infaltion. Real yield curves can be obsereved which have already had inflation priced in. Investors expect yields to rise to reward them for predicting a rise in inflation = yield curve rises. To counter this, centeral banks can raise IRs in the short term to counter this pressure but this means medium/long dated bond prices fall. because it is assumed action from the central bank will remove the impact of inflation in the med/long term.

Answer 2

Time value of money can be expressed as the value of a recievable sum of £ in the future in today's terms by considering the prevailing IR = sum's present value. Establishing present values AKA discoutning with the IR acting as the discount rate. Basically how much your money will be worth in the future compared to how much it is worth now.

Answer 3

**1/(1+r)^n** r=prevailing IR n= years E.g £1000 nominal value paying 10% coupon annually. 5% IR over 2 years = * Y1: 100X 1/(1+0.05) * Y2:1100X 1/(1+0.05)^2 = £1100 total return after 2 years (10% coupon at end of first year + nominal payout at maturity)

Answer 4

Debt Management Office (DMO) Same features of a corporate bond - coupon, nominal value, typically bi-annual coupon payment

Answer 5

Ex dividend= determines who recieves the coupon payment. Period of time prior to coupon payment to determine who the holder of th bond is/who recieves coupon

Answer 6

Normal trading time for the bond. There is a coupon payment in the future that has not been paid out yet.

Answer 7

The amount of moeny invested that is guaranteed to be returned to the investor (as it holds no risk).

Answer 8

* Examples: Index linked guilts (ILG) and US TIPS. They are based on published inflation indexes such as the retail price index (RPI) and CPI. * The + is that their price will increase with inflation, preserving the true value. * In 0% inflation ILBs will pay coupon rate with no adjustment. * There is no deflation floor in gilts which protects bonds returning less nominal value

Answer 9

**Real IR= [(1+nominal IR) ——————————- -1 (1 + inflation rate)]

Answer 10

* Harmonised index of consumer prices - later renamed to consumer price index (CPI). **CPI** target inflation = 2%. Set by monetary policy comittee in the BoE. EU wide * **Producer price indicies (PPI)** measure inflationary pressures at early stages in the production process, e.g. raw materials at wholesale level. * **Retail price index (RPI)** - avrg. measure of change in the prices of goods and services. once published, it is not revised.

Answer 11

Zero coupon bonds (ZCBs) - only return nominal value at maturity, the coupon is stripped off the bond and sold seperately.

Answer 12

P 48 table

Answer 13

Can be split into money borrowed from banks and money borrowed from investors (bonds) Debt financing is cheaper than equity as it is less risky for investors a bond holders are paid before equity holders.

Answer 14

Secured debt decreases the risk of default as assets of the issuer are offered as guarantee in the case of default. * Fixed charge= debt secured by a specific physcial asset e.g. a buidling * Floating charge= debt secured by a group of non current assets (e.g. bonds) Call debenture in the UK

Answer 15

Bonds backed by specific pool of assets (mortgages, credit card recieveables and car loans). This debt is securitised by big banks. Assets provide bondholders collateral as the cash generated from the pool of assets is used to pay off bonds coupons and nominals at maturity.

Answer 16

Financial instruments (credit card debt, mortgages, etc) are packaged together and used as a way to obtain funds/profit.

Answer 17

An example of an asset backed security. A group of mortgage loans that are packaged together and sold to investors. As the homeowner pays their mortgage, the investor recieves coupons and a nominal repayment. Typically divided into sub classes (tranches) with differing risk levels and payment schedules e.g. first tranche is paid first and teh fourth paid last= higher risk.

Answer 18

SPVs used to lower the risk of default on ABSs. usually a trust of the issuer of the assets. 2 purposes 1. Seperate from the issuing entity=the assets leave the issuers balance sheet and are replaced by cash payment from teh SPV. AKA off-balance sheet arangement. 2. SPVs are standalone entities so if the issuer of the assets goes bankrupt, the SPV remains and can continue to pay bondholders. AKA bankrupty remote = increased credit worthiness

Answer 19

Instances where no SPV is created AB bonds are referred to as **covered bonds** Classed as senior secured debt securities issued by a regulated financial institution. If the bank defaults, collateral is used to pay bondholders regardless if the bank has defaulted (as long as there is enough collateral)

Answer 20

The property of the issuing company is mortgaged to the bondholders as collateral for the money the company owes. However, a trust deed is put in place between the firm and investors saying they will be repaid the money trusted to the firm.

Answer 21

* Note trustee - represents the interests of the bondholders+provides guidance to the issuer * Security trustee - holds the securities for the benefit of the bondholders. * Share trustee - Holds the shares in an issuing SPV to achieve off balance sheet treatment - basically it is the SPV * Successor trustee - role is provided for banks in the event they need to resign from being the debt issuer to avoid conflict of interest

Answer 22

* Outlines the powers of the trustee acting on behal of all of the investors.Enables clear management/organisation. * Ensures all holders are paid what they are owed * + to the issuer as if the trust does something illegal, it is a seperate entity so the disputes stops at the trust. * Cheaper to have 1 trustee running the show than loads.

Answer 23

* Trustee is assigned to represent the interests of teh bondholders. * Engages the services of a credit rating agency to give potential investors a risk profile. However trustees can essential pay credit agencies for higher ratings * Trustee responsible for tracking bondgolers/ensuring obligations are met *

Answer 24

Ranks bondholders in seniority marking who is entitled to be repaid first. * **Senior debt** - debt ranks above all other debt/equity in a business and is paid first. Lowest IR as it is the most secure. Has strcit requirements * **Subordinated debt** - ranks below senior debt - Less strict requirements and a higher interest rate. * **Mezzanine debt** - High risk form of subordinated debt. Ranks last from the above and unsecured debt. Much higher IR compared to the above to reflect high risk. If not all interest or paid it can be marked as payment in kind and given to the investor as options.

Answer 25

* No protection for the investor if the firm defaults. * Higher interest to compensate the investor for the higher risk * Subordinated debt is typically unsecured and investors will be paid after other creditors if there is enough cash left after winding up

Answer 26

A guarantee is provided by someone other than the issuer (a guarantor) to pay the sum due if teh issuer defaults in return for a fixed payment every month eg.

Answer 27

* Standard and Poor's * Moody's * Fitch ratings Bonds are ranked into investment grade or non investment grade (junk). Some ABSs can have a 'credit enhanced' rating due to insurance protection in teh event of default. See table page 58

Answer 28

Lower coupon and longer dated

Answer 29

Facilitates reverse repos from GEMMs to cover shorts. Facilitated by the standing repo function

Answer 30

US, UK, German - max maturity 30years Japan max maturity 40 France max maturity 50 UK, US, Japan semi annual coupon German and French is annual coupon