Chapter 7 Flashcards
What is the PV of a bond?
Par value = face value, principal amount the issuer must pay back at maturity
What is the significance of the discount rate?
Discount rate = rate at which you would discount a FV to determine the PV
Discount rate is chosen based on the risk of the particular bond
What is the significance of the sum of the PV of a bond’s coupon and principal?
Fair price of a bond
If you were told that a 7% semi-annual bond matures in 5 years at discount rate of 4%, demonstrate the price of the bond
PV OF THE INCOME STREAM:
PV OF THE PRINCIPAL:
PV OF THE BOND:
T-bill has a price of 97.45 and matures in 69 days, demonstrate how to calculate annual yield
Yield = 100 - Price / Price X 365 / term X 100
Yield = 100 - 97.45 / 97.45 X 365 / 69 X 100
Define the current yield of a bond
Current yield only looks at cash flows and the current market price of an investment. NOT what was originally invested
Current Yield = annual cash flow / current market price x 100
What is the formula for the approximate YTM
A 4 year, semi-annual, 9% bond, trading at 96.77
N = 8 PMT = 4.50 PV = -96.77 FV = 100 COMP I/Y
I/Y = 4.9997
What is the difference between current yield, approximate yield, and YTM?
Current yield: looks only at cash flows and current market price of an investment, NOT amount originally invested
Approximate yield:
YTM: reflects investors return in the form of coupon income + any capital gain from purchasing the bond at discount or capital loss from purchasing bond at premium. YTM takes into account; current market price, term to maturity, par value at maturity, and coupon rate
What is reinvestment risk?
The risk that the coupons will earn a return at lower overall rate than the rate that prevailed at the time the bond was purchased is the reinvestment risk
What is the difference between the nominal and real rate of return?
Nominal rate of return: includes inflation
Real rate of return: removes inflation
Compare a normal yield curve to inverted yield curve
Normal yield curve; up right
Inverted yield curve ; down right
Describe the 3 theories proposed to describe the shape of the yield curve
Expectations Theory: current long-term interest rates foreshadow future short-term rates. 1 long term bond = 2 short term bonds
Liquid Preference Theory: investors prefer short term bonds, they are more liquid and less volatile
Market Segment Theory: various institutional players concentrate in specific term sector
Describe the relationship between bond prices and interest rates
Interest rates rise = bond yield rise + bond price falls
Interest rates fall = bond yield fall + bond price rises
Interest rates and bond yields match, bond price does opposite
Describe the impact of different maturity lengths on bond prices
Long term bonds are more volatile than short term bonds
As bonds approach maturity, they become less volatile
Describe the impact of different coupon rates on bond prices
Lower coupon bonds are more volatile in price change than high-coupon bonds
When yields rise, bond prices drop, but lower coupon bonds will drop significantly more
Describe the impact of yield changes on bond prices
Bond prices are more volatile when interest rates are low
Relative yield change is more important than absolute yield change
What does the duration of a bond describe?
Duration is the measure of the sensitivity of a bond’s price to change in interest rates
Duration helps investors to determine the bond’s volatility (amount of change)
Higher duration = higher percentage change for a yield
Explain the buy side and sell side
Buy Side = investment management. buying and holding of securities on behalf of clients. PM/Trader
Sell Side = trading investment products for their own accounts. creating, producing, researching, marketing, and trading products. Investment banker/Trader/Sales representative
What role does an inter-dealer broker play in the bond market?
Participants in the wholesale bond market
Act as agents, bringing together institutional buyers and sellers
Perform price discovery, trade execution, clearing and settlement
Inter-dealer brokers handle significant volumes
Provides anonymity
Name the information contained in the electronic information known as the trade ticket
Electronic confirmation sent through secure system includes;
specific details of trade, identification of bond, CUSIP and ID number, value of transaction, price, settlement, etc.
Describe the settlement rules for Government of Canada t-bills
Canadian T-bills settle the same day
Describe the settlement rules for common shares
Securities, bonds, certificates and shares settle on second clearing day after transaction
Differences between bearer bonds and registered bonds
Bearer bonds: certificate is produced, detachable coupons are attached to residual principal payment. Investor detaches coupons to submit to bank. Ownership is physical possession
Registered bonds: bear the name of the owner, and sold only when the owner signed the back of the certificate. Coupon payments mailed to owner
Defined accrued interest
Accrued interest is the amount of interest built up during the previous holding period
Accrued interest = Par amount X Coupon rate / 100 X Time period / 365
You purchased a 7% Government of Canada 300k face value bond, due March 20 2025, for price of 98.425 on Monday May 22. Calculate accrued interest
March 21 - 31 = 11 days
April = 30 days
May = 24 days (includes 2 days for settlement)
Total days = 65 days
300k X (7.00 / 100) X (65 days / 365)
What is a bond index
Index measures the relative value and performance of a group of securities over time
What is the best-known bond index that tracks broad Canadian bond markets
FTSE Global Debt Capital Markets: offers a comprehensive set of Canadian bond indexes
