Debt Instruments Flashcards
Difference between a bearer and registered bond?
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
What’s the par value of a bond?
$1000
How is current yield calculated?
Annual interest income divided by current market value
What does yield-to-maturity measure?
Investor’s total overall return – yearly interest received and appreciation/depreciation in value at maturity
If a bond is trading at a discount, what’s the relationship between current yield and yield-to-maturity?
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)
What’s the effect of a rise in interest rates on yield?
Remember coupon is fixed. So to increase yield to maintain its position relative to rising interest rates, price must fall
What does a normal, positive, ascending, upward sloping yield curve show?
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
Which fluctuates more? Short term yields or long term yields?
Short term yields
Terms preventing an issuer from calling a bond for a specified time are known as…
Call protection
Describe defeasance…
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
What is interest rate risk?
Market price of bonds held declines as rates rise
What is reinvestment risk?
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)
What is call risk?
If coupon rate is higher than current market norm, issue may be called and you lose the high coupon
Rank these two factors in any investment decision in bonds:
- maturity
- issuer
- Issuer
- 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)
How do you eliminate interest rate risk?
Invest in zero coupon bond (one issued at a discount, maturing at face value)
When would refunding typically occur?
When interest rates are lower than when the bond was issued
Changing interest rates will affect the price of which bonds most: short maturities or long maturities?
Long maturities.
How does current yield (coupon/price) relate to coupon and Yield-to-maturity?
It will always be between the two. If coupon larger than YTM then trading above par.
What does trading flat mean?
Without accrued interest.
Best strategy to eliminate interest rate risk?
Invest in short maturities like T-bills
