Chapter Six Flashcards
Do UK treasury bills pay interest?
- They pay no interest and are issued at a discount
Maturity of treasury bills?
They are short-term, less than one year
Why are treasury bills issued?
To manage the amount of cash in the banking system and are considered to be default risk free
How is the annualised yield on a t-bill calculated?
Using a 365 day count convention
What is true about an open repo?
Has no predetermined date for the repurchase element
How does BofE conduct interest rate policy?
Through its repo operations
Who issues a cerificate of deposit?
Can only be issued by institutions with a UK banking licence therefore carrying limited credit risk
Credit risk of CD?
With the issuing bank
What is a CD?
Certificate of deposit
In the UK, are CDs given deposit guarantees
No
Are CPs normally unsecured?
Yes
Can CDs have a term above one year?
Yes
What is SONIA?
Sterling Overnight Index Average. It is the preferred sterling risk-free rate benchmark in bond, loan and derivatives markets
What will SONIA include?
Overnight unsecured transactions which will be negotiated bilaterally as well as those arranged via brokers
How is SONIA calculated?
By the BoE however it is set by the banks involved in the transaction
A security which preserves the value of its purchasing power over time, despite increases in the general price level is known as?
An inflation hedge, as inflation is a measure of the purchasing power
Do treasury bills trade on a discount basis?
Yes
What is the minimum deposit for a certificate of deposit?
Normally 100k
What is likely to trade at a premium?
CDs. Treasure bills and commercial paper do not pay interest but give a return by trading at a discount.
What is true about FRN?
FRN coupons reset to market rates regularly and hence trade close to par
In a repo, is the interest charge higher than other sources of borrowing?
No it is only accepted by an eligible bank
Does a CP typically have a maturity up to five years?
No, typically less than 12 months
Does the quoted annualised yield on a treasury bill always exceed the true compounded annualised return?
No, the compound yield exceeds to quoted yield as it compounds the return rather than pro rating
How are CDs issued?
In demoninations of 10,000
What are FRN coupons linked to?
Money market rates
What is the minimum block size for treasury bills?
25k
Is the income on FRN guaranteed?
No it varies
Is a repo unsecured?
No it is a secured debt
Is the buyer of a repo more concerned about the credit worthiness of the borrower than the quality of the securities used in the repo?
The quality of the repod securities is of prime importance
What is the most likely reason for investing in commercial paper?
Capital gain
What is commercial paper?
A short-term instrument issued by a company with no security attached to it and with no interest
How does commercial paper create a rate of return?
It is issued as a discount to its par value and hence an investor will experience an increase in value
What is true about floating rate notes (FRNs)?
They pay a variable coupon and as a result trade near par. They are generally long term despite trading as money market instruments
As interest rates fall, what is true of FRN?
The price will remain constant and the yield will fall
When is a 2028-2030 treasury repayable?
The bond is repayable at a time selected by the DMO between 2028 and 2030 though it must be redeemed by 2030 at the latest
If a coupon rate on a bond increases, the duration of the bond will?
Lower coupon bonds are more sensitive to interest rate changes than higher coupon bonds and therefore have higher durations
High inflation reduces institutional demand for?
Non-indexed linked gilts. ILGs, equity and property are real returning assets that are protected from inflation which is important to investors with long term investment horizons
What is the market value of a fixed rate irredeemable bond?
Coupon rate divided by yield
What coupon is most sensitive to interest rate changes?
Low coupon long dated stock are the most sensitive to interest rate changes
Which is the normal style of coupon payment for gilts?
Semi-annually gross
Are Eurobonds registered securities?
No
Are Eurobonds international bond issues underwritten by a syndicate of banks
Yes
What regulates the Eurobond markets
ICMA - International Capital Market Association
Are interest of Eurobonds paid without any tax being deducted?
Yes
Which of the following yield calculations for a gilt would be most useful for a higher rate taxpayer?
Net redemption yield since it takes into account after tax cash flows from coupons
Gilt issues categorisation
Long: more than 15 years
Medium: 7 to 15 years
Short: Less than 7 years
Ultra short: under three years
If interest rates increase, what is true of gilts?
Gilt prices have an inverse relationship to changes in interest rates/yields. The sensitivity of a particular bond to yield changes is measured by duration
Which yield is most useful to establish the income return on a gilt investment?
The flat yield as it only assesses the income return and ignores the capital gain or loss on redemption. It is most appropriate for irredeemable bonds
What is the most suitable investment for an investor who believes that interest rates will fall
With falling interest rates bond prices will be rising. Low-coupon, long-dated gilts will be most sensitive to this and rise the furthest
If a long and short dated gilt both have the same market price, what will happen if interest rates increase
The longer dated stock is more volatile and would have the highest duration
If a gilt has a maturity and a coupon of 6% and current interest rates are 4% what is true?
The DMO will aim to redeem the gilt at the earliest opportunity
Can a callable bond be sold to the issuer at any time?
A callable bond may be called by the issuer, not sold to the issuer
Does senior unsecured debt have a lower risk than subordinated debt?
Yes
What is a serial note?
Where a proportion of the capital is repaid each year
What is a sinking fund?
Where a proportion of the bonds in issue are redeemed each year
Describe index linked gilts
The coupon and redemption are linked to the retail price index either three or eight months prior to the date in question.
What are ILGs described as?
They are described as ‘real’ returning assets as they offer protection against inflation which is why the coupon and redemption are scaled up by the inflationary uplift.
What is the correct order for repayment in the event of liquidation?
Preference shares, ordinary shares, and then deferred shares.
How do warrants fit into the order for repayment?
It is possible to have warrants issued to subscribe to new shares in the company which would rank last, after deferred shares
How are preference shares deemed?
They are deemed to be cumulative in terms of their dividend entitlements however some are deemed as non-cumulative
What is the highest junk bond rating?
BB+ is the highest. (BB+, BB, BB-)
What is the lowest IG bond rating?
BBB-
What are investment grade and high yield bonds?
Bonds rated as BBB- (Baa3) or above are IG, whereas those below are high yield
What is convexity?
Convexity ensures the actual price always exceeds the modified duration prediction
When can a putable bond be sold?
At the holder’s option
When can a callable bond be redeemed?
At the issuer’s option
When a convertible be converted
At the holder’s option
What is true about a bond that is irredeemable?
It is a bond that has no maturity or redemption date, i.e. it can never be redeemed and so is valued as a perpetuity
Explain convexity
It is the difference between actual prices and modified duration predictions. By using a modified duration, we are assuming a linear relationship
What is the gross redemption yield?
Assuming no tax is paid
What type of bond would rise to the greatest extent for a given fall in interest rates?
Low coupon, long dated
Cumulative preference shares, ordinary shares, deferred shares and convertible bonds in order
Bonds, preference shares, ordinary shares, deferred shares
What is the lowest IG bond rating?
BBB-
What is the inverted yield curve?
Short-term rates are high but the market anticipates that this can’t last for long so short-term interest rates are expected to fall
What is the zero-coupon rate?
The spot rate
What is a droplock FRN?
A minimum value for the coupon rate is set so if it falls below this value then the issue is converted into a bond issue for the remainder of its life
What is a CoCos?
A contingent convertible. It is a form of debt that is converted into equity if a pre-specified trigger event occurs such as the capitalisation falling below a certain level
When do CoCos convert?
Automatically on the occurence of a trigger event.
