Debt Securities Flashcards
This deck focuses on the general characteristics of fixed income securities, including bond pricing, bond yields, and various types of risks associated with bonds.
1
Q
Equivalent of 100 basis points
A
1%
2
Q
Regular way settlement for corporate bonds
A
T + 1
3
Q
Regular way settlement for municipal bonds
A
T + 1
4
Q
Regular way settlement for agency securities
A
T + 2
5
Q
Regular way settlement for Treasuries
A
T + 1
6
Q
Frequency of interest payments to bondholders
A
Semi-annual
7
Q
Par value of a corporate bond
A
$1,000
8
Q
Relationship between bond prices and bond yields
A
Inverse
9
Q
Value of one bond point
A
$10
10
Q
A bond that is priced below par
A
Discount
11
Q
Use a 360-day year in the calculation of accrued interest
A
Municipal and corporate bonds
12
Q
Use a 365-day year in the calculation of accrued interest
A
U.S. Government bonds and notes
13
Q
Of YTC, YTM and CY, the yield that is highest when a bond is trading at a premium and is callable
A
Current Yield (CY)
14
Q
Of YTM, YTC and CY, the yield that is highest when a bond is trading at a discount and is callable
A
Yield to Call (YTC)
15
Q
Of YTM, YTC and CY, the yield that is lowest when a bond is trading at a discount
A
Current Yield (CY)
16
Q
Of YTM, YTC and CY, the yield that is lowest when a bond is trading at a premium and is callable
A
Yield to call (YTC)
17
Q
Amount a bondholder receives at maturity of an ABC 9% bond
A
$1045 (par + 1 semiannual interest payment)
18
Q
Amount of interest paid every 6 months on 5,000 XYZ 6% bonds
A
$150 ($30 semiannual interest per bond x 5 bonds)
19
Q
Securities that are not represented by a physical certificate
A
Book Entry securities
20
Q
Interest payment varies based on performance of an index
A
Variable rate or adjustable rate bonds
21
Q
The date in the future at which a bondholder receives principal
A
Maturity
22
Q
Of long-term and short-term bonds, which generally pays a higher interest amount?
A
Long-term bonds
23
Q
Of long-term and short-term bonds, which generally has lower price volatility?
A
Short-term bonds
24
Q
The degree of risk associated with an issuer’s ability to repay the principal
A
Credit or default risk
25
A bond that is rated BBB or above by Standard and Poor's
Investment Grade
26
A bond that may be redeemed by the issuer prior to its maturity date
Callable bond
27
Risk that a bond may be called prior to maturity
Call risk
28
The process of calling bonds when interest rates have fallen
Refunding
29
Special account in which Issuer funds are set aside in advance of a call
Sinking fund
30
Specific time period from date of issue when a bond cannot be called
Call Protection Period
31
Type of bond issue that is not typically callable
U.S. Government bonds (Treasury bonds)
32
Risk that proceeds from a called bond cannot be invested as favorably
Reinvestment risk
33
Annual interest divided by current market price
Current Yield (CY)
34
Purchased at a deep discount; pays no interest during the life of the bond
Zero-coupon bond
35
The price of a bond quoted at 105
$1,050
36
The price of a bond quoted at 97
$970
37
How bond prices are quoted
As a percentage of par
38
The difference in basis points between 6.20% and 6.50%
30 basis points
39
An issuer with outstanding bonds that have a 5% coupon issues similar new bonds with a 6% coupon. The outstanding bonds will trade at a
Discount
40
An issuer with outstanding bonds that have a 5% coupon issues similar new bonds with a 4% coupon. The outstanding bonds will trade at a
Premium
41
An investor buys a 6% bond trading at a 6.5% basis. The bond is purchased at a
Discount
42
An investor buys a 6% bond trading at a 5.5% basis. The bond is purchased at a
Premium
43
An ATT ZR 13 bond will pay how much to the owner at maturity?
## Footnote
ZR = zero coupon bond
$1,000
44
The corporate practice of raising money to call outstanding bonds
Refunding
45
Bonds sold at a deep discount because of their credit rating
Junk bonds
46
A bond that is held in the bondholder's name
Registered bond
47
The type of risk rated by Moody's, Standard & Poor's and Fitch
Default or Credit Risk
48
The risk that the issuer will not be able to pay the principal and interest owed on outstanding debt securities
Default or Credit Risk
49
Amount above par that an issuer may pay to call bonds
Call premium
50
A bond which can be sold at face value back to the issuer prior to maturity at pre-determined times
Puttable bond
51
The formula for computing current yield
Annual interest divided by current market price
52
Another name for the coupon yield, which is set at the issuance of the bond
Nominal
53
Two companies that rate bond issues
Moody's and Standard and Poor's (also Fitch)
54
The date on which interest on new municipal bonds begins to accrue
Dated date
55
Regular way settlement for municipal securities
T + 2
56
Number of days per year in the calculation of accrued interest for municipal bonds
360
57
accrued interest
The interest paid by the buyer of a bond to the seller of a bond when a bond is traded between interest payments. It is calculated from the previous interest payment date, including that date, up to, but not including, the settlement date.
58
balloon bond
A type of bond issuance with a mix of serial and term bond characteristics: some debt matures each year, but the bulk of the principal matures on one final date. These bonds are quoted based on their yield to maturity.
59
basis point (bps)
A unit of measurement that helps to reflect bond yields. One basis point equals 0.01% of par and therefore there are 100 bps in 1.00%.
60
bearer form
A form of registration where the name of the owner is not recorded with the issuer. Instead, payment of interest and principal are made to the investor in physical possession of the bond certificates and interest coupons that can be clipped from the bond. Fixed-income securities are no longer issued in this form.
61
bond
A security issued by a corporation or governmental entity to raise capital. It represents a loan to a borrower, not ownership, with the borrower having a legal obligation to pay investors a stated interest payment for a set period of time.
62
bond duration
A calculation that measures the sensitivity of a bond's price to interest rate movements. Bonds with a longer duration are more volatile given changes in rates.
63
book-entry form
A type of bond registration where the investor's ownership of bonds is recorded electronically in lieu of the owner receiving a physical certificate.
64
call protection
A time period in which the issuer cannot call the bonds regardless of what happens to interest rates. During this period, investors are protected from their bonds being called away.
65
call risk
The risk that a bond or other callable investment will be redeemed by the company prior to maturity. This risk is typically prevalent in an environment in which interest rates are falling, since companies call so that they can refinance and lower their interest expense.
66
callable
A feature of a security such as a bond or preferred stock making it so that the issuer has the right to buy it back prior to maturity. Typically, an issuer will exercise this feature when interest rates decline so that they can issue a replacement security at a lower rate.
67
coupon
Also referred to as the nominal yield, it is the stated rate of interest that an investor receives.
68
credit rating
Measures the risk of default by an issuer.
69
credit risk
The risk that an issuer will be unable to make interest or principal payments to investors.
70
creditor
A person or company who is owed money. An example might be the purchaser of a bond who is owed both regular interest payments throughout the life of the bond and the face amount at maturity.
71
current refunding
A method of refinancing by selling cheaper debt to immediately call back more expensive callable bonds. An issuer is most likely to refund in an environment where interest rates are falling.
72
current yield
The return of a bond based on its current market price. It is calculated as the annual interest payment divided by the current price of the bond.
73
dated date
The first date that interest begins to accrue for a new-issue bond.
74
escrow account
An account typically held with a bank for safekeeping.
75
fixed-rate bond
A bond that pays the same amount of semiannual interest until maturity.
76
high-yield bond
Also referred to as a junk bond, it is a non-investment-grade bond that has a higher chance of default. To be considered a high-yield bond, a bond must have a rating by Moody's or S&P/ Fitch of Ba1 or BB+ respectively.
77
inflationary risk
The risk that as inflation increases, the purchasing power of an investor's fixed coupon will decrease essentially, that the fixed coupon payment will not go as far for the investor as the price of goods and services rises.
78
investment grade
A bond rating that reflects a lower chance of default. To be considered investment grade, a bond must have a rating by Moody's or S&P/Fitch of at least Baa3 or BBB- respectively.
79
inverse relationship
The relationship between interest rates and bond prices and the fact that they move in opposite directions.
80
LIBOR
The interest rate at which some of the world's leading banks charge each other for short-term loans. It is often used as a benchmark rate for various products, such as adjustable rate preferred stock and variable rate bonds.
81
maturity date
The future date on which a bondholder receives his final semiannual coupon payment and his principal is returned.
82
municipal securities
Issuances by states, cities, counties, and their agencies to support their day-to-day obligations and finance many projects for the public good.
83
par value
The nominal or face value amount of a security. For common stock this is an arbitrary number (i.e., $1.00 or less) and has no real significance. For both preferred stock and bonds it is significant, as the respective dividend and interest payments on these securities are quoted as a percentage of par. For preferred, par is typically $100, and for bonds, par is typically $1,000.
84
put feature
Gives investors the right to sell the bond back to the issuer, typically at par, if some predetermined event, such as a bond rating downgrade or a rise in interest rates, occurs.
85
refinancing
The process of replacing a higher interest rate loan with a new loan at a lower rate of interest.
86
refunding
The process by which an issuer refinances, selling cheaper bonds at a lower rate to replace more expensive, callable bonds before maturity. For example, a company sells 6% bonds to replace 9% bonds, lowering its interest expenses by 3% per year.
87
registered form
A form of registration where the name of the owner is recorded with the issuer or a transfer agent on behalf of the issuer.
88
reinvestment risk
The risk that as interest rates decrease, the fixed coupon payments that an investor receives will be put back into the market at a lower rate of return. Because zero-coupon bonds do not pay interest, they do not face reinvestment risk.
89
serial bond
A type of bond issuance where the bonds mature over different dates at a regular interval. They are quoted based on their yield to maturity.
90
sinking fund
An account in which a bond issuer regularly sets aside money (typically in an escrow account) for the redemption of bonds before maturity. This makes the issuance safer and more marketable.
91
term bond
A type of bond issuance in which all the bonds mature at once. Sometimes the bonds are referred to as dollar bonds because they are typically quoted based on their price, expressed as a percentage of par.
92
trading flat
Said of a bond that does not pay accrued interest, such as a zero or a bond currently in default.
93
variable rate bond
A type of bond that pays an adjustable rate of return, typically based on the performance of a specific benchmark, such as LIBOR or the T-bill rate.
94
yield to call (YTC)
A rate of return on a bond (yield) that accounts for the difference between the purchase price and the amount of proceeds received on the earliest call date.
95
yield to maturity (YTM)
A rate of return on a bond (yield) that accounts for the difference between the purchase price and the amount of principal received at maturity. It is typically the most widely quoted yield for bonds.
96
yield to worst (YTW)
The lower of yield to call or yield to maturity and because it conveys the worst return an investor might receive, it must be printed on the trade confirmation. For a discount bond, the YTW is the yield to maturity, and for a premium bond it is the earliest yield to call.
97
zero-coupon bond
A type of bond that does not pay annual interest. Instead, these bonds are issued at a discount and mature at par, the difference between the two reflecting the investor's return. Typically, they are most suitable for an investor saving for a future event because the investor can put up less cash up front, while receiving the full amount of principal at maturity.
98
Describe the relationship between price and yield for all fixed-income securities.
**Inverse Relationship**
When interest rates fall, bond prices rise and when interest rates increase, bond prices will decrease.
99
How often do most bonds pay interest?
Most bonds pay semi-annual interest. There are two exceptions:
1. Zeros, which do not pay annual interest. Instead, they are issued at a discount and mature at par and
2. Mortgage-backed securities, which pay interest monthly.
100
What occurs on the maturity date of a bond?
At maturity, the investor receives back their principal as well as their final semi-annual coupon payment.
101
What is book-entry form?
Book-entry is the most common method of tracking ownership of debt and equity securities. It allows an investor's ownership to be recorded electronically by a central depository.
102
At maturity, how much principal is owed for each bond an investor holds?
**$1,000**
## Footnote
The par value of most bonds is $1,000. So if a customer buys 100 bonds, the customer has an investment of $100,000 (100 bonds x $1,000 per bond) due at maturity.
103
What is the **interest rate** on a bond called?
A bond's **coupon rate**, also called the **nominal yield**, describes the amount of interest the bond pays.
104
What are the benefits of callable bonds?
The right to call, or retire before maturity, benefits the issuer of the security because it allows the issuer to re-issue new debt at the presumably lower, current interest rates.
## Footnote
The issuer would only call a bond in a lower rate environment, since it would not be beneficial to the issuer to issue new debt at rates higher than the existing issue.
105
What governs the callability of a bond?
**The Call Provision**
## Footnote
This is a legal agreement, typically between the bond issuer and the investor, that governs under what conditions and at what price a bond may be called.
106
What is the meaning of call protection?
This is a period of time defined in the bond's indenture during which the bond cannot be called, no matter what happens to interest rates.
107
What risk does an investor face if their bond is called?
The investor will face reinvestment rate risk as they will need to take the proceeds from their bond and reinvest them back into the market at a time when interest rates are falling.
108
When the issuer redeems bonds prior to maturity, what might they pay investors?
**The Call Premium**
## Footnote
The call premium is an amount above par paid to investors that compensates them for losing their bond prior to maturity. This amount typically declines as the bond gets closer to its maturity date.
109
Who owns the option in a putable bond?
**The Investor**
## Footnote
A put feature allows the investor to sell back the bond to the issuer, typically at par, if some pre-determined event occurs.
110
What are the two primary sources of bond ratings?
**Moody's and Standard and Poor's**
111
Which firm uses lower-case letters in bond ratings?
**Moody's**
## Footnote
Moody's differentiates their ratings from Standard & Poor's by using a leading capital letter.
For example, an AAA rating from S&P is equivalent to Aaa from Moody's.
112
A bond is quoted at 107. What is the dollar price?
**$1070**
## Footnote
Bonds are typically quoted as a percentage of par. A quote of 107 is 107% of par, which is $1,070.
113
What is it called when bonds trade below or above par respectively?
**Discount Bond or Premium Bond**
## Footnote
Bonds trading below par are called discount bonds, and those trading above par are called premium bonds.
114
What is a basis point?
The basis point, or "bip," is the most common way to describe changes in yield. One basis point equals 0.01% and therefore there are 100 basis points in 1%. For example, a bond going from 1.00% to 1.01% has increased in yield by one basis point.
115
Describe the relationship between a bond's price and interest rates.
Bond prices and interest rates have an **inverse relationship**. As interest rates increase bond prices will decrease and as rates fall, bond prices will increase.
116
What is the nominal yield of a bond?
The nominal yield is synonymous with the coupon rate of a bond. It is the amount of annual interest that the investor will receive over the life of the bond.
117
Some bonds do not pay periodic interest, but instead are sold at a discount to par or face value. What are these bonds called?
**Zero-coupon Bonds**
118
What are two factors that impact bond price volatility?
**coupon; maturity**
## Footnote
Long-term, low coupon bonds (including zeros) will be most impacted by a change in interest rates.
119
A coupon on a bond indicates:
**Interest income for the holder**
120
The risk that a bond will be called prior to maturity is known as
**Call Risk**
## Footnote
Call risk is the risk that a debt security will be called prior to maturity. This will occur in an environment when interest rates are falling.
121
There are several types of risk associated with investing in debt securities. The risk that the issuer will not make timely payments of principal and interest is called
**credit risk**
122
If the market interest rate is below the coupon rate, the bond will sell at a:
**Premium to par value**
123
For a given change in yield, bonds with higher coupons undergo:
**Smaller price changes than those on bonds with lower coupons**
## Footnote
This relationship shows that bond price volatility is inversely related to coupon size.
124
A bond selling at $1,100, with a principal of $1,000 and a coupon rate of 7% will pay annual interest of
**$70**
## Footnote
The annual interest is the fixed coupon paid by the bond.
125
Calculate current yield for an 8%, 7-year bond whose price is $940.
**8.51%**
## Footnote
Current yield is calculated as the annual interest of $80 divided by the market price of $940.
126
A bond that includes a provision that allows the issuer to retire the bond prior to the stated maturity date is known as a:
**Callable bond**
## Footnote
A callable bond allows the issuer to retire the bond prior to the stated maturity date. This gives the issuer a certain level of protection, because if rates decline a sufficient amount, the issuer may call outstanding bonds and replace them with lower-rate debt.
127
When a yield-to-maturity is above the coupon rate, the bond will be priced to its par value:
**At a discount**
128
You are considering purchasing a bond that does not make periodic interest payments, and which is trading at a significant discount to its par value. What type of bond are you considering for purchase?
**Zero-coupon bond**
129
As a portfolio manager, you have a significant portion of your bond portfolio maturing in the next few weeks. You are concerned that rates have dropped since you purchased these bonds and that the yields that you will get by reinvesting the proceeds will be smaller than what you now are receiving. This type of risk associated with investing in debt securities is known as
**Reinvestment rate risk**
130
A call premium is the additional:
**Amount the issuer must pay the bondholder for the option to call the bond**
## Footnote
A call premium makes a callable bond more attractive to an investor. Although the investor may not want the bond to be retired by the issuer, the call premium serves as an incentive for an investor to accept that risk.
131
John Smith has purchased an investment grade debt security. Included with this debt security is the right to sell the bond back to the issuer at a specified price and date. This type of option is known as a
**Put feature**
