Chapter 7 - Investing In Debt

Question 1

How do we value a bond with a fixed coupon

Answer 1

Work out the present value of anticipated future cash flows

Question 2

What is a general equation for bond value

Answer 2

Cash flows / 1 + interest rate

Question 3

What is the equation for valuing an irredeemable bond

Answer 3

Bond value = cash flow / interest rate (perpetuity)

Question 4

What is the better term to use than the flat yield

Answer 4

The gross redemption yield

Question 5

When should an investment in debt be measured at amortized cost (2 conditions)

Answer 5

1. The asset is held within a business model whose objective is to hold financial assets in order to collect the contractual cash flows
2. Contractual terms of financial asset give rise on specified dates to cash flows that are solely payments of principle and interest on the principal amount outstanding

Question 6

When should an investment in debt be classified as FVTOCI (2 conditions)

Answer 6

1. Business model whose objective is achieved both by collecting the contractual cash flows and selling the financial assets
2. contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding

Question 7

How can some debt investments be categorized as FVTPL

Answer 7

Irrevocable election at initial recognition if doing so eliminates or significantly reduces a recognition inconsistency (accounting mismatch)

Question 8

How is an amortized cost debt investment measured at initial recognition

What about subsequent measurement

Answer 8

Initial: measure at FV including transaction costs

Subsequent:

Initial value
+ interest income at EIR
- coupon
- allowance for ECL

Question 9

How is an FVTOCI debt investment measured at initial recognition

What about subsequent measurement

Answer 9

Initial: at fair value including transaction costs

Subsequent:
Revalue to fair value
Gains/losses to FVOTCI reserve in OCI
Interest income, FX gains/ losses to P/L
Impairment losses recognized in P/L and OCI - they do not reduce the carrying amount of the asset

Question 10

How is an FVTPL debt investment measured at initial recognition

What about subsequent measurement

Answer 10

Initial: at fair value with transaction costs separate expense through P/L

Subsequent:
Revalue to fair value
Gains/losses to P/L
Interest income and FX gains/ losses to P/L

Question 11

How do you define a preference share

Answer 11

Pays a fixed percentage dividend if there is available distributable profit - more risky than bonds

Question 12

How are convertible bonds classified usually

Answer 12

Due to the dividend payments upon conversion, convertible bonds fail the SPPI condition and must be classified as FVTPL

Question 13

Which 3 types of bonds are more sensitive to interest rate changes

Answer 13

Long maturity bonds - cash flow of principle further in future which is more affected by discounting

Low or zero coupon bonds - greater proportion (all) cash flows happen at redemption

Low yield bonds - lower discount factors lead to higher PV of final redemption payment

Question 14

What is the equation for modified duration

Answer 14

Macaulay duration / 1 + GRY

Question 15

What is the equation for the expected change in price in relation to Macaulay duration

Answer 15

Expected change in price = modified duration * change in yield * bond price * -1

Question 16

What is the equation for the duration gap

Answer 16

Duration gap = duration of assets - (duration of liabs * (value of liabs/ value of assets))

Where the duration of assets and duration of liabs are weighted averages