Chapter 9: Bond Markets Flashcards
What is the GRY
GRY is the gross redemption yield, the return we expect to get if we hold a bond until the redemption and coupons are reinvested at the same rate
What is the relationship between prices and GRY
Inversely proportional, i.e., if the one goes up the other one goes down.
What causes is there for return not equal to GRY
- Default
- Return eroded by inflation
- Expenses and tax affects the net return
- Currencies movements for overseas bonds
- May sell a bond before redemption, thus only getting the holding period return
In the exam do they refer to GRY of HPR when referring to yield and return respectively
Yield = GRY HPR = Either GRY or HPR, discuss both.
What questions do you ask to discuss a cashflow question?
- The general definition of the product and cashflows involved (dividends, coupons, etc)
- Is it positive or negative cashflow?
- Is it a sum assured or regular payments?
- Is the size assured or regular payments known or unknown in advance?
- Is the sum assured or regular payments known or unknown in advance?
- Is the timing of the payments known or unknown in advance?
- Is the term the payments are being made known or unknown in advance?
Discuss the income of a conventional government bond from the investor’s perspective
Regular coupons (e.g., twice a year), level in amount, are only known in nominal terms (unknown in real terms). The coupon is paid until redemption and there is a possibility of default.
At redemption, the investor receives a lump sum amount. Redemption can either at par, premium or discount. Amount known in nominal terms, timing is also known and there is the existence of default risk
Discuss the characteristics of government bonds
S - Security
* Depends on the security of the of issuing
Y - Yield
- Held until redemption = GRY
- Known in nominal but not real terms
- HPR if not held until redemption depends on the sale price
- Lower than equities
S - Spread
* Provide diversification from other asset classes
* LT bonds have more volatile prices than ST bonds
*
T - Term
* ST, MT, LT or irredeemable
E - Expenses
* Dealing cost low
E - Exchange rate
* Risk for bonds issued in foreign currency
M - Marketability
- Highly marketable
- Large issue
- Listed on the stock exchange
T - Tax
* Depends on the territory
What is an index-linked bond?
Bond where coupons and redemption amount are linked to inflation (real return)
What is the relationship between nominal and real yields?
nominal (FIB) = real (ILB) + E(Inflation) + IRP (Inflation Risk Premium)
What is the inflation risk premium?
The additional return required for bearing uncertainty surrounding inflation
When to buy an FIB over an ILB?
When we expect the inflation or inflation risk premium to fall
Economic influences of bonds
- Interest rates
- Inflation
- Fiscal deficit
- Institutional cashflows
- Exchange rate
