Debt Market Flashcards
What is a bond?
A promissory note or security issued by a borrower (business or government unit) that obligates the issuer to make specified fixed payments to the holder over a specific period (usually long term)
What are the features of a bond?
1) Par Value: Stated face value of the bond
2) Coupon payment: Interest($) paid to the lender each period (Can be made annually, semi-annually, quarterly)
3) Coupon rate: Coupon payment divided by the par value
4) Maturity date: The date whereby the par will be repaid
5) Price: Price at which the bond can be bought or sold (Sold at par, premium, or discount)
6) Yield to maturity: Yield of the bond if one holds till maturity, assuming that each coupon is reinvested at the same rate (Basically - risk free rate + all the other factors)
What is a zero-coupon yield?
Yield on a zero-coupon bond.
*Equation in notes
Facts about bonds?
1) Bond price and market interest rates are negatively related
- When market interest rates increase, bond price will decrease
2) Bond with a longer maturity is more price sensitive than a bond with shorter maturity when interest rates changes, c.p
3) Bond with a lower coupon rate is more price sensitive than a bond with higher coupon rate
4) For any bond, a given increase in interest rate will cause a smaller price change than a decrease in interest rate of the same magnitude (rmb the convexity of the bond curve)
2+3) How to tell which bond is more volatile if the bond has higher coupon rate and longer maturity?
Look at the Duration/Maturity
How do you determine the default-free, short-term, real interest rate of a specific bond?
1) Anticipated inflation: Price of bond lower if anticipated inflation is high
- Inflation will erode cash flows
- Inflation will cause interest rates to increase, causing bond prices to decrease (Inverse relationship)
2) Term to Maturity: Longer term, more risky as it is more sensitive to interest rate changes. Thus, interest rates will be high.
3) Default/credit risk: If issuer perceived credit quality deteriorates, they will incur a higher risks, causing interest rates to increase and price of bond to drop
4) Optional features: Callable, puttable, convertible
5) Event risk, liquidity, tax status, exchange rate risk
* Value of options will be priced into bonds, depending on who the option favours
What are the different types of bonds?
1) Level-coupon bonds
2) Perpetual bonds
3) Pure discount bonds
4) Callable bonds
5) Convertible bonds
6) Floating rate bonds
7) Domestic bonds
8) Eurobonds
9) Asian Dollar bonds
10) Foreign bonds
11) Dim Sum bonds
12) Panda bonds
13) Diaspora bonds
14) Green bonds
15) Social Impact bonds
16) Catastrophic bonds
17) Pandemic bonds
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What is a Level-coupon bond?
Most common type
Periodic fixed (level) coupon payments [constant coupon rate]
*Equation in slides
What is a Perpetual bond?
Pays a constant stream of coupon forever
It NEVER matures.
- Bond seller can keep the principal payment as long as he/she wants
Perpetual bond price = Cash flow (periodic coupon payment) / i (market required return)
What is a Pure Discount bond?
Zero-coupon bonds.
Bonds that make no coupon payments and is thus priced at a deep discount.
Only discount 1 cash flow back to t=0
*Equation in notes
What is a Callable bond?
Bonds that contains a call provision.
Gives the issuer the right to call the bonds for redemption before maturity.
Risk involved:
EMBEDDED PREPAYMENT RISK
- The issuer can call back the bond for pre-payment before maturity
- Causes risk to increase
- Yield will be higher as we demand a higher return to reward risk-taking
- Bond price will decrease
*If call issuer benefits, this means bad news for the bond holder
What is a Convertible bond?
Bonds that allow holders to convert bonds to stocks at a pre-specified ratio.
This favours bondholders.
WHY?
- Stocks are a long-term instrument
- There are a lot of upside potential if the stock does well
Lower yield (for convertible feature), therefore higher bond price.
If the company is doing badly, they can use contingent convertible bonds to convert debt to equity (bad for bondholders).
What is a Floating rate bond?
Bonds with coupon payments that are adjustable, normally tied to an interest rate index (e.g. LIBOR, SIBOR)
These bonds usually trade close to par.
WHY?
What is a Domestic bond?
Market of issue = currency = nationality of issuer
E.g. US$ bond placed in US by US firms
&
SIA issuing SGD bonds in SG
What is a Eurobond?
Bonds issued and sold outside the country of the currency in which they are denominated.
- Currency of the bond is different from the place it is issued
E.g. US$ denominated bonds issued in Europe and not issued in the US
What is an Asian Dollar bond?
A subset of euro-dollar bond.
Place of issue: Asia
E.g. USD bond not traded in the US, but in Asia
What is a Euro-yen/Euro-won/Euro-euro bond?
1) Euro-yen: Yen bond sold outside of Japan (Does not need to be issued in Europe)
2) Euro-won: Won bond issues outside of Korea
3) Euro-euro: Euro-denominated bond sold outside of Europe
What is a Foreign bond?
Market of issue = currency =/ nationality of issuer
- Bond issuer must be a foreigner
- A local cannot issue a foreign bond
Bonds issued outside of the issuer’s country, usually denominated in the currency of the country in which they are issued.
e.g. US$ bond placed in US by non-US firms
What is a Dim Sum bond?
CNY denominated bond issued outside of China by a Chinese firm.
Similar to an Eurobond but NOT an Eurobond. Not a Foreign bond.
- Because Hong Kong is part of China
Mostly done in Hong Kong where the ‘outside of china’ is Hong Kong.
What is a Panda bond?
China’s version of foreign bonds.
Not accessible to many issuers.
A Chinese renminbi-denominated bond from a non-Chinese issuer, sold in the People’s Republic of China.