Chapter 3 - Specialist asset classes (1) Flashcards
LIBOR
London Interbank Offered Rate
Treasury Bills
Money market instruments issued by the government
Commercial paper
Short-term unsecured debt issued by a company
Repos
Agreement whereby one party sells stock to another party with a simultaneous agreement to repurchase it at a later date at an agreed price
Government agency securities
Securities issued by near-government institutions that are almost as risk-free and liquid as Treasury bill and government bonds
Bank time deposit
A bank deposit that has a specified term
Evergreen credit
Permission to borrow up to a specified limit, with no fixed maturity
Revolving credit
Permission to borrow up to a specified limit, with a fixed maturity of up to 3 years
Primary reasons for higher yield on corporate bond (compared to government bond)
- Increased default risk
- Liquidity/Marketability risk
Credit derivatives
Contracts where the payoff depends partly on the credit-worthiness of one (or more) commercial (or sovereign) bond issuers
Two most common types:
- Credit default swaps (CDS)
- Credit spread options
Credit default swap
A contract that provides a payoff if a particular credit event occurs eg.
- Bankruptcy
- A ratings downgrade
- Cross-default
Two way of settlement of a CDS
- A pure cash payment
- Physical settlement whereby both a security and cash are exchanged
Credit-linked note
Consists of a basic security plus an embedded CDS
Credit spread option
An option on the spread of the yields earned on two assets
Interest rate swaps
One party, Company A, agrees to pay another party, Company B, cashflows equal to interest at a predetermined fixed rate on a notional amount for a number of years.
At the same time, Company B agrees to pay Company A cashflows equal to interest at a floating rate on a notional amount for the same period of time.
The swap has the effect of changing the nature of an asset/liability from fixed(floating) to floating(fixed)
Step-up swaps
A swap where the principal amount increases in a predetermined way
Amortising swap
A swap where the principal reduces in a predetermined way
Total return swap
A swap wherein the receiver receives the total return on a reference asset in return for paying the reference floating rate with an adjustment
RPI and LPI swaps
RPI swap: A swap where one set of payments is linked to the level of the retail price index (RPI)
LPI swap: Same as above but capped at a maximum rate
Swaption
An option on swaps (swaption) provides one party with the right to enter into a certain swap at a certain time in the future
