Chapter 7 Flashcards
What is the most accurate method used to determine the value of bond?
Present value (sum of money on a specific date in the future).
What are the step to calculate PV?
- Appropriate i
- PV from coupon
- PV principal
- Sum up.
What is the discount rate (i)?
is the rate at which the future value is discount to present value
What factor affect the discount rate i?
- risk
- yields currently applicable to bonds with similar coupon, term and credit quality
- Market condition
- often = risk free rate + spread
What is the formula to calculate the yield on T-bill?
Yield = (100 - p ) / p * 365/term * 100
What is current yield on a bond?
Current yield looks only at cash flows and the current market price of an investment, not at the amount that was invested.
How to calculate the current yield on a bond?
Current yield = annual cash flow /current market price * 100%
What is yield to maturity (YTM)?
is the total return you would expect to earn over the life of a bond starting today, assuming you are able to reinvest each coupon payment at the same YTM.
How to approximate calculate YTM?
AYTM = (interest income +- price change per compounding period)/((purchase price + par)/2) * 100%
Price change per compounding period = (par - price)/N
In which case Current yield = YTM = AYTM?
when price = par value
What is reinvestment risk?
is the risk that the coupons will earn a return at a lower overall rate than the rate at the time the bond was purchased
What does “YTM at the time of purchase would be understated” mean?
when coupon payments are reinvested at the rate higher than the bond’s YTM at the time of purchase.
What does “YTM at the time of purchase would be overstated” mean?
when coupon payments are reinvested at the rate lower than the bond’s YTM at the time of purchase.
Which bond has no reinvestment risk?
Zero coupon bond.
What is Fisher theory?
Nominal rate = real rate + inflation rate
What is yield curve?
Relationship between long-term and short-term yields.
-> base on real number -> with same credit quality, the longer the term, the higher the yield.
What are the theories that attempt to explain the shape of the yield curve?
Expectations theory, liquidity preference theory and market segmentation theory.
What is expectations theory about?
long-term interest rates foreshadow future short-term rate -> investors buying a single long-term bond should expect to earn the same amount of interest as they would buying 2 short-term bonds of equal combined duration -> the shape of the yield curve indicates investor expectations about the future interest rates.
What is the formula to calculate rate in expectation theory?
(1 + r2y) binh phuong = (1 + ry1) (1+ ry2)
What is liquidity preference theory about?
investors prefer short-term bonds because they are more liquid and less volatile in price -> need compensation to buy long-term bonds.
What is market segmentation theory about?
yield curve represents the supply of and demand for bonds of various terms.
How many types of yield curve?
- normal upward-sloping curve
- Inverted (downward sloping)
- humped curve (up and down)
What is the relationship between bond yields and interest rate?
are often used interchangeably and both mean a rate of return on an investment -> interest rate rise, bon yields also rise. (because the coupon rate doesn’t change -> price will have to change so that bond yield can keep up with interest rate)
What is the relationship between interest rate and bond price?
Interest rate rise, bond price fall
What is the difference between longer-term bonds and shorter-term bond?
Longer-term bond are more volatile in price than shorter-term bonds.
what is the relationship between lower-coupon bonds and high-coupon bonds?
Lower-coupon bonds are more volatile in price percentage change than high-coupon bonds
what is more important changing in absolute yields or relative yields?
Relative yield change is more important than the absolute yield change.
What is duration?
a measure of the sensitivity of the bond’s price to changes in interest rate (the approximate percentage change in the price or value of a bond for a 1% change in interest rate) -> the higher the duration, the more the bond will react to change in interest rate.
what is volatility?
the amount of change in price as interest rate change.
What does it mean when a bond has duration 10?
That mean its price will change approximately 10% for each 1% change in interest rate.
What will you do when you expect interest rate will increase?
Buying bond with low duration
What does the sell-side do?
Creating, producing, distributing, researching, marketing, and trading fixed-income product
What are the sell-side fixed-income primary role?
- Investment banker
- Trader
- Sale representative
What is the investment bank role of sell-side about?
Help clients to structure new debt issues and bring the to primary market
What is Trader role of sell-side about?
Trade securities in secondary market
What is Sale representatives role of sell-side about?
Sale representative in primary and secondary market, conduct research, provide market analysis, credit analysis, and commentary, take clients orders
What is the buy-side fixed-income trading do?
Mostly investment management (engaged in the buying and holding securities for their institutional clients
What us the main role if buy-side in fixed income investment management duties?
- Portfolio manager
2. Trader
What is the role of trading firm when trading with large institutional dealing desk?
Investment advisor are typically served by a retail trading desk which help advisors sourcing products and providing market commentary
What is the advantage of dealing within a larger firm?
- access to the wide range of securities in its inventory -> allows for automatic execution of trades once the advisor enters them into system.
- for larger trades and some illiquid securities, trades must executed over the phone
What is the difference of trading in firms without a large institutional dealing desk?
the trading desk must build its own inventory of product and sourcing product that it does not own from other dealers.
What is inter-dealer brokers?
are participants in the wholesale bond market (the bond market between the institutional buy side and sell side)
What does inter-dealer broker do?
act solely as agents, bring together institutional buyers and seller in matching trades. -> discovering price, perform trade execution, clearing and settlement, sometimes public transparency of prices.
What is the main advantage of inter-dealer broker?
provide anonymity (an danh).
What is the mechanics of the trade?
- all non-electric trade must be over the phone which is recorded and all parties use key words and clear language to communicate.
- must deliver and pay on the settlement date.
What is the trade ticket?
is an electronic confirmation sent through secure, proprietary systems.
What information is on the trade ticket?
- Specific details (counter parties)
- ID of bond
- The bond’s committee on uniform security Identification procedure (CUSIP) or other electronic settlement identification number
- The nominal, par, or face amount of the transaction.
- the price and often the yield
- the settlement date
- the name of the custodian where the trade will settle
- Total settlement amount sometimes with accrued interest shown separately.
When will the securities delivered?
Until the end of settlement period when payment is made
How long is the settlement period?
Depends
- T-Bills on the same transaction day
- bond, debentures, certificates of indebtedness preferred shares, and common shares on the second clearing day after the transaction day.
What are the different types of fixed-income securities ownership?
- Bearer bonds
- Registered bonds
- Bonds registered in book-based format.
What is the characteristic of bearer bonds?
- detachable coupons attached to principal payment
- investors detach the coupon and submit to the bank or financial institution to receive payment
- Ownership is signified by physical possession
What is the characteristic of registered bonds?
- cannot be sold or transferred only when owner signs the back of the certificate
- coupon payments are mailed to registered owner
What is the characteristic of bonds registered in book-based format?
- an electronic record keeping system used by depositories that keeps track of ownership and settlement of securities transactions. (by CDS clearing and depository services Inc.)
If the bond maturity date is Feb 15, 2025. When will the interest be paid?
every Feb 15 and August 15 until maturity.
What is the formula to calculate the accrued interest?
= par amount * coupon rate /100 * time period/365
What is accrued interest?
interest from the previous payment date up to and including the settlement date.
What is an index?
index measures the relative value and performance of a group of securities over times.
What is bond indexes are used?
- as a guide performance of overall bond market or segment of that market
- performance measurement tool
- construct bond index funds.
What is the popular bond index in Canada?
FTSE global debt capital markets offers a index called FTSE Canada universe bond index which consists of bonds representing a full cross-section of government and corporate bonds.
What are popular bond index for global?
FTSE World Government Bond Index
What are popular bond index for US?
Bloomberg Barclays U.S. Aggregate Bond Index
US Broad Investment-Grade Bond Index
What are popular bond index for Government bond?
FTSE UK Gilts Index Series
MAX Hungarian Government Bond Index Series
What are popular bond index for emerging market bonds?
J.P. Morgan Emerging Markets Bond Index
J.P. Morgan Government Bond Index-Emerging Markets
What are popular bond index for high-yield bonds?
Credit Suisse High Yield Index
ICE Bank of America US High Yield Master II Total Return Index
When calculate accrued interest, will you count the trading date or settlement date and will you include the last day of interest payment?
Including settlement date and excluding the last day of payment (Since clearing days are business days only, you have to adjust for weekends and holidays.)
bond price is more volatile when interest rate are low, correct?
yes. Also long term bond are more volatile than short-term, low coupon is more volatile than high coupon
