Debt Instruments

Question 1

Difference between a bearer and registered bond?

Answer 1

Bearer bond doesn’t have name of owner on the bond or the books of the corporation.
Bearer bonds and bonds registered to the principal only have interest coupons attached.
Fully registered bonds don’t - interest paid to registered holder

Question 2

What’s the par value of a bond?

Answer 2

$1000

Question 3

How is current yield calculated?

Answer 3

Annual interest income divided by current market value

Question 4

What does yield-to-maturity measure?

Answer 4

Investor’s total overall return – yearly interest received and appreciation/depreciation in value at maturity

Question 5

If a bond is trading at a discount, what’s the relationship between current yield and yield-to-maturity?

Answer 5

Yield-to-maturity will be higher than current yield as there’s an appreciation between current market price and the value at maturity
(And vice versa if trading at a premium)

Question 6

What’s the effect of a rise in interest rates on yield?

Answer 6

Remember coupon is fixed. So to increase yield to maintain its position relative to rising interest rates, price must fall

Question 7

What does a normal, positive, ascending, upward sloping yield curve show?

Answer 7

Yields increase with maturity, but to a diminishing degree as yield differences between 20-25 year are less than yield differences between 5-10 years
This is the yield curve under all but extreme market conditions

Question 8

Which fluctuates more? Short term yields or long term yields?

Answer 8

Short term yields

Question 9

Terms preventing an issuer from calling a bond for a specified time are known as…

Answer 9

Call protection

Question 10

Describe defeasance…

Answer 10

Issuer floats a new release with proceeds escrowed into government bonds to meet calls.
As the original issue is secured by escrow, the issuer’s responsibilities terminate and bond holder’s rights and liens end

Question 11

What is interest rate risk?

Answer 11

Market price of bonds held declines as rates rise

Question 12

What is reinvestment risk?

Answer 12

Calculation of yield to maturity assumes reinvestment of interest at same rate as yield to maturity – this might not be possible
(T/f doesn’t apply to zero coupon bonds)

Question 13

What is call risk?

Answer 13

If coupon rate is higher than current market norm, issue may be called and you lose the high coupon

Question 14

Rank these two factors in any investment decision in bonds:

• maturity
• issuer

Answer 14

1. Issuer
2. Maturity
   Longer the maturity – the greater the exposure to interest rate risk
   Belief interest rates will rise – invest in short term bonds (price will decline less than long term and on maturity invest at higher rate). Belief they will fall, invest long term (price will rise more and lock in higher rate)

Question 15

How do you eliminate interest rate risk?

Answer 15

Invest in zero coupon bond (one issued at a discount, maturing at face value)

Question 16

When would refunding typically occur?

Answer 16

When interest rates are lower than when the bond was issued

Question 17

Changing interest rates will affect the price of which bonds most: short maturities or long maturities?

Answer 17

Long maturities.

Question 18

How does current yield (coupon/price) relate to coupon and Yield-to-maturity?

Answer 18

It will always be between the two. If coupon larger than YTM then trading above par.

Question 19

What does trading flat mean?

Answer 19

Without accrued interest.

Question 20

Best strategy to eliminate interest rate risk?

Answer 20

Invest in short maturities like T-bills