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Fixed Income > Fabozzi - 2 > Flashcards

Fabozzi - 2 Flashcards

1
Q

What is interest rate risk?

A

It refers to the adverse price movement of a bond as a result of a change in market interest rates.

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2
Q

What is call risk?

A

It is the risk that a security will be paid prior to the scheduled principal payment dates.

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3
Q

What is reinvestment risk?

A

It is the risk that interest and principal payments must be reinvested at a lower interest rate.

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4
Q

What is default risk?

A

It is the risk that the issuer will fail to satisfy the terms of indebtedness with respect to the timely payment of interest and principal.

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5
Q

What is credit spread risk?

A

It is the risk that the price of an issuer’s bond will decline due to an increase in the credit spread.

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6
Q

What is downgrade risk?

A

It is the risk that one or more of the rating agencies will reduce the credit rating of an issue or issuer.

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7
Q

What are the three main rating agencies in the U.S.?

A

Standard & Poor’s, Moody’s, and Fitch.

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8
Q

What does a credit rating represent?

A

It is an indicator of the potential default risk associated with a particular bond issue.

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9
Q

What is liquidity risk?

A

It is the risk that the investor will have to sell a bond below its indicated value.

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10
Q

What is the bid-ask spread?

A

It is the difference between the highest bid price and the lowest ask price from among dealers.

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11
Q

What is exchange rate risk?

A

It is the risk that the currency in which the bond’s payments are made will decline relative to the domestic currency.

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12
Q

What is inflation risk?

A

It is the risk that the cash flows of a security will decline in value due to inflation.

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13
Q

What is volatility risk?

A

It is the risk that the price of a bond with an embedded option will decline when expected yield volatility changes.

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14
Q

What is event risk?

A

It is the risk that the issuer’s ability to make payments changes dramatically due to unforeseen events.

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15
Q

What is sovereign risk?

A

It is the risk that a foreign government’s actions cause a default or adverse price decline on its bond issue.

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16
Q

How is the price of a callable bond calculated?

A

The price of a callable bond equals the price of an option-free bond minus the price of the embedded call option.

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17
Q

What is the relationship between interest rates and bond prices?

A

Bond prices change inversely with a change in market interest rates.

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18
Q

How does bond maturity affect interest rate risk?

A

The longer the bond’s maturity, the greater the price sensitivity to changes in interest rates.

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19
Q

How does the coupon rate affect interest rate risk?

A

The lower the coupon rate, the greater the bond’s price sensitivity to changes in interest rates.

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20
Q

What is the price sensitivity of a callable bond compared to an option-free bond?

A

The price of a callable bond will not fall as much as an option-free bond when interest rates rise.

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21
Q

How is duration defined in bond analysis?

A

Duration measures the price sensitivity of a bond to interest rate changes.

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22
Q

What does key rate duration measure?

A

It measures the approximate percentage price change for a 100 basis point change in the interest rate for one maturity.

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23
Q

What is a zero-coupon bond?

A

It is a bond that has no reinvestment risk but has greater interest rate risk than a coupon bond of the same maturity.

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24
Q

What is a rating transition matrix?

A

It shows the change in credit ratings over some time period.

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25
Q

What is cap risk in a floating-rate security?

A

It is the risk that the floater has a cap on interest rates, limiting potential increases.

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26
Q

What is yield curve risk?

A

It is the risk that a portfolio’s value will differ if interest rates increase by different amounts at different maturities.

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27
Q

What does a portfolio’s duration measure?

A

It measures the sensitivity of the portfolio’s value to changes in interest rates assuming a parallel yield curve shift.

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28
Q

What is parallel yield curve shift?

A

It is when interest rates change by the same amount for all maturities.

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29
Q

How is the price of a putable bond calculated?

A

It equals the price of an option-free bond plus the price of the embedded put option.

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30
Q

How is the percentage price change of a bond calculated?

A

By averaging the percentage price change due to the same increase and decrease in interest rates.

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31
Q

What is the relationship between interest rates and the price of an embedded call option?

A

As interest rates rise, the price of the embedded call option decreases.

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32
Q

What is the risk for a floating-rate security with a daily reset?

A

There is still interest rate risk because the margin required by the market may change.

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33
Q

What is the risk when a floater has a cap?

A

The interest rate cannot exceed the cap, limiting the investor’s potential returns.

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34
Q

What is the effect of yield volatility on a callable bond?

A

When expected yield volatility increases, the price of a callable bond decreases.

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35
Q

What is the effect of yield volatility on a putable bond?

A

When expected yield volatility decreases, the price of a putable bond decreases.

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36
Q

How does inflation risk affect a bond?

A

Inflation reduces the purchasing power of the bond’s cash flows.

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37
Q

What is the adverse effect of event risk?

A

It can dramatically and unexpectedly affect an issuer’s ability to make interest and principal payments.

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38
Q

What are the three forms of credit risk?

A

Default risk, credit spread risk, and downgrade risk.

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39
Q

What is the primary measure of liquidity risk?

A

The size of the spread between the bid and ask price quoted by dealers.

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40
Q

What is the relationship between the level of interest rates and a bond’s price sensitivity?

A

The higher the interest rate, the lower the price sensitivity to interest rate changes.

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41
Q

What is the main disadvantage of a callable bond to an investor?

A

The cash flow pattern is uncertain due to the possibility of early repayment.

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42
Q

What is the disadvantage of prepayable securities for investors?

A

They expose investors to greater reinvestment risk than nonamortizing securities.

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43
Q

What is the advantage of a zero-coupon bond regarding reinvestment risk?

A

It has no reinvestment risk.

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44
Q

What does a rating downgrade signify?

A

It indicates a reduction in the credit quality of the bond or issuer.

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45
Q

What is the risk of holding a bond in a foreign currency?

A

The bondholder faces exchange rate risk.

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46
Q

What is a bid price?

A

It is the highest price a buyer is willing to pay for a security.

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47
Q

What is an ask price?

A

It is the lowest price a seller is willing to accept for a security.

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48
Q

What happens to the price of an option-free bond when interest rates rise?

A

The price of the option-free bond decreases.

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49
Q

What is the impact of maturity on a bond’s interest rate risk?

A

Longer maturities increase the interest rate risk.

50
Q

What is the purpose of using a duration calculation?

A

It helps approximate the percentage price change of a bond when interest rates change.

51
Q

What happens to the price of a callable bond when interest rates rise?

A

The price of the callable bond does not fall as much as an option-free bond.

52
Q

What is the price sensitivity of a bond?

A

It refers to how much the price of a bond changes when interest rates change.

53
Q

How is the percentage price change of a bond measured?

A

It is measured by the percentage change from the bond’s initial price.

54
Q

What is duration?

A

Duration is a measure of interest rate risk, showing how sensitive a bond’s price is to changes in interest rates.

55
Q

How do you calculate the duration of a bond?

A

Duration is calculated by estimating the bond’s price for an increase and decrease in interest rates.

56
Q

What does a portfolio’s duration assume?

A

It assumes that interest rates for all maturities change by the same amount.

57
Q

What is prepayment risk?

A

It is the risk that a security will be paid off earlier than expected.

58
Q

What is the relationship between reinvestment risk and prepayable securities?

A

Prepayable securities increase reinvestment risk because the proceeds must be reinvested at potentially lower rates.

59
Q

What is the effect of a call provision on capital appreciation?

A

It reduces the capital appreciation potential of the bond.

60
Q

What is a parallel yield curve shift?

A

It is when interest rates for all maturities change by the same amount.

61
Q

What is the reinvestment risk for a zero-coupon bond?

A

Zero-coupon bonds have no reinvestment risk.

62
Q

What is a rating upgrade?

A

It is when a bond’s credit rating is improved by a rating agency.

63
Q

What is yield volatility?

A

It refers to changes in the expected yield and how it affects bond prices, especially for bonds with embedded options.

64
Q

What is credit spread?

A

Credit spread is the difference in yield between a corporate bond and a government bond of the same maturity.

65
Q

What is event risk?

A

Event risk refers to the possibility of dramatic changes in an issuer’s ability to make payments due to unexpected events.

66
Q

What does sovereign risk refer to?

A

Sovereign risk is the risk of default or price decline due to actions taken by a foreign government.

67
Q

What is the purpose of a rating transition matrix?

A

It shows how credit ratings change over a certain period.

68
Q

What are the two components of liquidity risk?

A

The size of the bid-ask spread and the ease of trading the bond without affecting its price.

69
Q

What is the primary characteristic of a floating-rate bond?

A

Its coupon payments adjust periodically based on a reference interest rate.

70
Q

What is the main disadvantage of a prepayable security?

A

It exposes the investor to reinvestment risk.

71
Q

How does yield volatility affect a bond with an embedded option?

A

Changes in yield volatility can affect the value of the embedded option, impacting the bond’s price.

72
Q

What does exchange rate risk depend on?

A

It depends on changes in the value of the foreign currency relative to the domestic currency.

73
Q

What is the impact of inflation risk on bond cash flows?

A

Inflation reduces the purchasing power of the bond’s future cash flows.

74
Q

What does a rating downgrade signal to investors?

A

It indicates a higher risk of default or financial difficulty for the bond issuer.

75
Q

What is the relationship between interest rates and bond prices?

A

There is an inverse relationship; as interest rates rise, bond prices fall.

76
Q

What is the purpose of calculating duration?

A

It helps estimate the sensitivity of a bond’s price to interest rate changes.

77
Q

What is key rate duration?

A

It measures the price sensitivity of a bond to changes in interest rates at specific maturities.

78
Q

What is credit risk?

A

It refers to the risk that the issuer will not make timely payments of principal and interest.

79
Q

What is downgrade risk?

A

It is the risk that a bond’s credit rating will be lowered by a rating agency.

80
Q

What is the relationship between coupon rate and price sensitivity?

A

The lower the coupon rate, the higher the bond’s price sensitivity to interest rate changes.

81
Q

How does bond maturity affect price sensitivity?

A

The longer the bond’s maturity, the greater its price sensitivity to interest rate changes.

82
Q

What happens to the value of an embedded call option when interest rates rise?

A

The value of the embedded call option decreases.

83
Q

What is a floating-rate security?

A

It is a bond whose coupon payments are adjusted based on changes in a reference interest rate.

84
Q

What is the main feature of a callable bond?

A

A callable bond can be repaid by the issuer before its maturity.

85
Q

What does liquidity risk imply for a bondholder?

A

It means the bondholder may have to sell the bond below its fair value due to low market liquidity.

86
Q

What does prepayment risk refer to?

A

It is the risk that the issuer will repay the bond earlier than expected, affecting the investor’s returns.

87
Q

How does a rating upgrade affect a bond?

A

It improves the bond’s creditworthiness and often increases its price.

88
Q

What is the impact of a callable bond’s embedded option on price?

A

The price of a callable bond is lower than an option-free bond due to the value of the embedded call option.

89
Q

What is reinvestment risk for a coupon bond?

A

It is the risk that coupon payments will have to be reinvested at a lower interest rate than the bond’s coupon rate.

90
Q

What are the two main types of credit risk?

A

Default risk and downgrade risk.

91
Q

What happens to a bond’s price if credit spreads widen?

A

The bond’s price will decrease.

92
Q

How does exchange rate risk affect bondholders?

A

Bondholders may lose value if the foreign currency depreciates against their domestic currency.

93
Q

What is the definition of inflation risk?

A

It is the risk that inflation will reduce the real value of a bond’s cash flows.

94
Q

How does yield volatility affect a callable bond?

A

Higher yield volatility decreases the value of a callable bond.

95
Q

What is sovereign risk?

A

It is the risk that a foreign government’s actions will negatively impact a bond’s value.

96
Q

What happens when interest rates increase for a bond portfolio with a high duration?

A

The portfolio’s value will decline significantly.

97
Q

What is the purpose of a callable bond?

A

It allows the issuer to repay the bond before maturity, typically when interest rates decline.

98
Q

What does a bond’s coupon rate represent?

A

It represents the interest rate the issuer agrees to pay on the bond’s face value.

99
Q

What is the inverse relationship between bond prices and interest rates?

A

When interest rates rise, bond prices fall, and when interest rates fall, bond prices rise.

100
Q

What is a premium bond?

A

It is a bond selling above its face value because its coupon rate is higher than the market interest rate.

101
Q

What is a discount bond?

A

A bond selling below its face value because its coupon rate is lower than the market interest rate.

102
Q

What is a par value bond?

A

A bond that is selling at its face value.

103
Q

How does a callable bond’s price react when interest rates rise?

A

The price of a callable bond decreases, but less than an option-free bond.

104
Q

What is an embedded option in a bond?

A

It is a feature that allows the issuer or the bondholder to take certain actions, such as calling or putting the bond.

105
Q

What is the impact of a bond’s maturity on interest rate risk?

A

The longer the maturity, the higher the interest rate risk.

106
Q

What is a coupon bond?

A

A bond that pays periodic interest based on its coupon rate.

107
Q

What is yield curve risk?

A

It is the risk that a bond portfolio’s value will be affected if interest rates change differently at various maturities.

108
Q

What is call risk?

A

The risk that a callable bond will be repaid before its maturity, typically when interest rates fall.

109
Q

What is a bond’s face value?

A

The principal amount of the bond that is repaid at maturity.

110
Q

What is the bid-ask spread in bond trading?

A

It is the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.

111
Q

What is credit spread risk?

A

It is the risk that a bond’s price will decrease due to an increase in the credit spread.

112
Q

What is the purpose of a rating agency?

A

To assess the creditworthiness of bond issuers and assign credit ratings.

113
Q

What is liquidity risk?

A

The risk that an investor may not be able to sell a bond at its market value due to a lack of buyers.

114
Q

What is a callable bond?

A

A bond that can be repaid by the issuer before its maturity date.

115
Q

How does inflation risk affect bondholders?

A

Inflation reduces the purchasing power of the bond’s future interest and principal payments.

116
Q

What is the duration of a bond?

A

It is a measure of the bond’s sensitivity to interest rate changes, indicating the percentage price change for a 1% change in interest rates.

117
Q

What does the term “yield” refer to in bonds?

A

Yield is the return on a bond based on its current market price and interest payments.

118
Q

What is the relationship between a bond’s coupon rate and its price?

A

If the coupon rate is higher than market interest rates, the bond will trade at a premium; if lower, at a discount.

119
Q

What does a floating-rate bond mean?

A

A bond where the interest payments fluctuate with changes in a reference interest rate.

120
Q

What is reinvestment risk for an amortizing security?

A

It is the risk that periodic principal payments will have to be reinvested at lower interest rates.

Fixed Income (5 decks)

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