Chapter 5- 5Qs Types And Characteristics Of Fixed Income

Question 1

Three major issuers of debt

Answer 1

Corporations
US government
Municipalities (Cities and state

Question 2

Treasury Bills

Answer 2

Sold at auction every week

4, 13,26 weeks

Once a month issue 52 week bills

Issued at discount and mature at par

Question 3

Us Treasury Notes

Answer 3

Semiannual interest payments at percent of par

Intermediate maturities (2, 3, 5, 7, 10)

Mature at par

Question 4

US Treasury Bonds

Answer 4

Semiannual interest

10-30 year maturities

Usually callable at 25 years

They mature at par (always 1000 on exam though could be as low as 100)

Question 5

TIPS

Answer 5

Issued with fixed interest rate and principal is adjusted by change in CPI semiannually

Protect against purchasing power risk

5, 10, and 30 year maturities

Interest = new principal times fixed rate

Subject to federal tax, have to report rise in principal as income

Question 6

Government agencies

Answer 6

GNMA is backed fully by the government (Pays interest monthly)

Fannie Mae and Freddie Mack are not guaranteed by gov because they are owned by shareholders

All taxed at federal and state

Question 7

Collateral trust bonds

Answer 7

Stock market collateral pledged as the security

Question 8

Debenture

Answer 8

Company with good credit standing offering debt without collateral

Question 9

Subordinated Debt

Answer 9

Lowest form of debt without equity backing (i.e. It is before Preferred stock)

Question 10

Debt taxation

Answer 10

Federal debt is only taxed at federal level

Munis not taxed at all normally

Bonds- Interest is taxed as ordinary income

Question 11

General Obligation Bonds

Answer 11

Backed by taxes

City, county and school district bonds have distinction of being secured by property taxes

Question 12

Revenue Bonds

Answer 12

Paid by the earnings of an enterprise

Could be: water, sewer, electric or gas, toll bridge, airport, college dorm

Yield is usually higher for revenue bonds

Have credit risk and possible alternative minimum tax on revenue bonds

Question 13

Investment grade

Answer 13

BBB or Baa and higher

Usually only quality eligible for purchase by institutions and fiduciaries

Bonds rated BB and lower are called High yield bonds

Question 14

Yield Spread

Answer 14

Difference between 2 different bonds i.e. government and corporate yields

Closer they get = Better economy

2 year note vs 10 year bond = Tighter would signal optimism

Question 15

Collateralize Mortgage Obligations (CMOs)

Answer 15

Debt securities collateralized by mortgages

Collateralized by each successive mortgage

Paid the interest being paid by the homeowner

Risk having the homeowner pay off their house and being unable to find a similar rate of return

Though to do a cash flow analysis when they mature at random intervals

Question 16

Callable Bonds

Answer 16

Allows issuer to redeem its bonds before maturity

OFten exercised if rates fall

Refunding- doing a new loan to pay off old loan with a higher rate

Question 17

Convertible bonds

Answer 17

Issued by corporations only

Exercised at discretion of the investor

Amount of convertible shares is in the bond indenture

Conversion ratio= number of shares

Bonds price will rise along with the stock

Corporations may call their convertible bonds to force conversion

Question 18

Zero coupon bonds

Answer 18

Issued at a discount

IRS requires a form 1099-OID be sent indicating taxable interest

Higher default risk than normal munis or corporate bonds because no income is received until maturity

Question 19

Nominal Yield

Answer 19

Coupon rate

Nominal yield X face = yield

Bond paying 6% semi annually would mean it pays a total of $60 not 120

Question 20

Current Yield

Answer 20

Annual interest / current price of bond

8% note currently trading at 800 has a 10% current yield

Question 21

Yield to maturity

Answer 21

Interest + (Discount/ year to maturity
/
Average price
Or
Interest - (premium / year to maturity
/
Average price

Also known as the market driven return because it reflects the IRR

Question 22

YTC

Answer 22

Reflects the acceleration of the profit or loss being realized in the YTM calculation

Question 23

Pricing of bonds

Answer 23

Municipal and corporate bonds are quoted as fractions

Government as points with each point being 1/32nd

101.8 for gov is 101 and 8/32

Question 24

Duration

Answer 24

The higher the coupon the shorter the duration tile repayment

If coupons the same shorter time till maturity the shorter duration

Question 25

Convexity

Answer 25

Measure of the curve from plotting bond price movements

Greater convexity means greater price movement on upside, smaller decrease on downside

Most useful in determining the price volatility of a bond to interest rate change

Question 26

Discounted cash flow

Answer 26

Looking at future cash flow being generated and discounting it back to present value

Adjusting for TVM

The higher the interest rate, the higher the discount taken