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Fixed Income > Fabozzi - 4 > Flashcards

Fabozzi - 4 Flashcards

1
Q

The interest rate offered on a particular bond issue depends on

A

the interest rate that can be earned on risk-free instruments and the perceived risks associated with the issue

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2
Q

The U.S. Federal Reserve Board is

A

the policy making body whose interest rate policy tools directly influence short-term interest rates and indirectly influence long-term interest rates in the United States

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3
Q

The Fed’s most frequently employed interest rate policy tools are

A

open market operations and changing the discount rate; less frequently used tools are changing bank reserve requirements and verbal persuasion to influence how bankers supply credit to businesses and consumers

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4
Q

The Treasury yield curve shows

A

the relationship between yield and maturity of on-the-run Treasury issues

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5
Q

The typical shape for the Treasury yield curve is

A

upward sloping—yield increases with maturity—which is referred to as a normal yield curve

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6
Q

Two factors complicate the relationship between maturity and yield as indicated by the Treasury yield curve:

A

(1) the yield for on-the-run issues can be financed at cheaper repo rates and, as a result, offer a lower yield than in the absence of this financing advantage and (2) on-the-run Treasury issues and off-the-run issues have different interest rate reinvestment risks.

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7
Q

Treasury STRIPS definition

A

Separate Trading of Registered Interest and Principal Securities are securities where the interest (coupons) and principal payments of a Treasury bond are separated, and each part is sold as an individual zero-coupon bond. Each STRIP represents a single payment at a future date (either a coupon payment or principal repayment)

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8
Q

Treasury spot rate definitoon

A

the yield on a zero-coupon or stripped Treasury security

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9
Q

The Term Structure of Interest Rates is

A

the relationship between maturity and Treasury spot rates

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10
Q

Three theories to explain the shape of the yield curve:

A

pure expectations theory, liquidity preference theory, and market segmentation theory

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11
Q

Pure expectations theory

A

asserts that the market sets yields based solely on expectations for future interest rates

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12
Q

According to the pure expectations theory:

A

(1) a rising term structure reflects an expectation that future short-term rates will rise, (2) a flat term structure reflects an expectation that future short-term rates will be mostly constant, and (3) a falling term structure reflects an expectation that future short-term rates will decline

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13
Q

Liquidity preference theory

A

market participants want to be compensated for the interest rate risk associated with holding longer-term bonds

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14
Q

The market segmentation theory asserts that

A

there are different maturity sectors of the yield curve and that each maturity sector is independent or segmented from the other maturity sectors. Within each maturity sector, the interest rate is determined by the supply and demand for funds

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15
Q

yield spread definition

A

a non-Treasury security’s additional yield over the nearest maturity on-the-run Treasury issue

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16
Q

The yield spread can be computed in three ways:

A

(1) the difference between the yield on two bonds or bond sectors (called the absolute yield spread), (2) the difference in yields as a percentage of the benchmark yield (called the relative yield spread), and (3) the ratio of the yield relative to the benchmark yield (called the yield ratio).

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17
Q

An intermarket yield spread is

A

the yield spread between two securities with the same maturity in two different sectors of the bond market.

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18
Q

An intramarket sector spread is

A

the yield spread between two issues within the same market sector.

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19
Q

The factors other than maturity that affect the intermarket and intramarket yield spreads are

A

(1) the relative credit risk of the two issues; (2) the presence of embedded options; (3) the relative liquidity of the two issues; and, (4) the taxability of the interest.

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20
Q

An issuer specific yield curve can be computed by

A

adding the yield spread, by maturity, for an issuer and the yield for on-the-run Treasury securities.

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21
Q

A credit spread or quality spread is

A

the yield spread between a non-Treasury security and a Treasury security that are ‘‘identical in all respects except for credit rating.’’

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22
Q

How and why does credit spread change between corporates and Treasuries

A

it changes systematically because of changes in economic prospects—widening in a declining economy (‘‘flight to quality’’) and narrowing in an expanding economy

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23
Q

The relationship between the yield spread and embedded options is

A

that investors require a larger spread for securities with options favorable to the issuer, and a smaller spread for those with options favorable to the investor

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24
Q

The option-adjusted spread of a security seeks to measure

A

the yield spread after adjusting for embedded options

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25
Q

Relationship between liquidity and yield spread

A

the larger the issue, the greater the liquidity, and therefore the lower the yield spread. Inverse relationship.

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26
Q

yield on municipial bonds vs Treasuries with the same maturity

A

because the former are tax-exempt, they have also lower yields

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27
Q

The difference in yield between tax-exempt securities and Treasury securities is typically measured in terms of

A

a yield ratio - the yield on a tax-exempt security as a percentage of the yield on a comparable Treasury security

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28
Q

The after-tax yield is computed by

A

multiplying the pre-tax yield by one minus the marginal tax rate

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29
Q

In the tax-exempt bond market, the benchmark for calculating yield spreads is

A

a generic AAA general obligation bond with a specified maturity

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30
Q

Funded investors who borrow short term typically measure the relative value of a security using

A

borrowing rates rather than the Treasury rate (i.e. EURIBOR). Because they pay that rate to have their investment funded.

31
Q

What happens in an interest rate swap?

A

two parties agree to exchange periodic interest payments with the dollar amount of the interest payments exchanged based on a notional principal (also called a notional amount). One party (the fixed-rate payer) agrees to pay to the counterparty fixed interest payments at designated dates for the life of the contract and the counterparty (the fixed-rate receiver) agrees to make interest rate payments that float with some reference rate

32
Q

What is the swap rate

A

the fixed rate paid by the fixed-rate payer in an interest rate swap

33
Q

The swap spread is

A

in an interest rate swap, the spread that the fixed-rate payer agrees to pay above the Treasury yield with the same term to maturity as the swap

34
Q

Institutional investors can use an interest rate swap to convert

A

a fixed-rate asset (or liability) into a floating-rate asset (or liability) and vice versa

35
Q

The swap spread is viewed by market participants throughout the world as

A

the appropriate spread measure for valuation and relative value analysis

36
Q

the swap rate reflects the premium that market participants must pay above

A

the risk-free Treasury rate to access borrowing or lending in the global swap market

37
Q

A wider swap spread might indicate

A

more credit risk or stress in the financial system, while a narrower spread could indicate more stability and lower borrowing costs

38
Q

A swap spread curve shows

A

the relationship between the swap rate and swap maturity for a given country

39
Q

A credit spread is

A

the difference in yield between a corporate bond (or other non-government security) and a Treasury bond of the same maturity

40
Q

There is correlation between swap spreads and credit spreads in various sectors of the bond market?

A

Yes, a lot.

41
Q

What does the Treasury yield curve show?

A

The relationship between yield and maturity of on-the-run Treasury issues.

42
Q

What is the typical shape for the Treasury yield curve?

A

Upward sloping, referred to as a normal yield curve.

43
Q

What does Treasury STRIPS stand for?

A

Separate Trading of Registered Interest and Principal Securities.

44
Q

What is the Treasury spot rate?

A

The yield on a zero-coupon or stripped Treasury security.

45
Q

What is the term structure of interest rates?

A

The relationship between maturity and Treasury spot rates.

46
Q

What does the pure expectations theory assert?

A

Yields are set based solely on expectations for future interest rates.

47
Q

What does the liquidity preference theory suggest?

A

Market participants want compensation for the interest rate risk of holding longer-term bonds.

48
Q

What does the market segmentation theory assert?

A

Each maturity sector of the yield curve is independent from the others.

49
Q

What is a yield spread?

A

The additional yield of a non-Treasury security over the nearest maturity on-the-run Treasury issue.

50
Q

What is an intermarket yield spread?

A

The yield spread between two securities with the same maturity in different sectors.

51
Q

What is an intramarket sector spread?

A

The yield spread between two issues within the same market sector.

52
Q

What is a credit spread?

A

The yield spread between a non-Treasury security and a Treasury security with the same maturity.

53
Q

What happens to credit spreads in a declining economy?

A

They widen due to a “flight to quality.”

54
Q

What is an option-adjusted spread?

A

A measure of yield spread after adjusting for embedded options.

55
Q

What happens to yield spread as liquidity increases?

A

Yield spread decreases as liquidity increases.

56
Q

How is the after-tax yield calculated?

A

By multiplying the pre-tax yield by one minus the marginal tax rate.

57
Q

What is LIBOR?

A

The London Interbank Offered Rate, important for investors borrowing short-term.

58
Q

What is an interest rate swap?

A

An agreement between two parties to exchange periodic interest payments.

59
Q

What is the swap rate?

A

The fixed rate paid by the fixed-rate payer in an interest rate swap.

60
Q

What is a swap spread?

A

The spread above the Treasury yield with the same maturity as the swap.

61
Q

What does the swap spread curve show?

A

The relationship between the swap rate and swap maturity for a given country.

62
Q

What is the relationship between swap spreads and credit spreads?

A

They are correlated across various bond market sectors.

63
Q

What does a wider swap spread indicate?

A

More credit risk or financial system stress.

64
Q

What is the yield on municipal bonds compared to Treasuries?

A

Municipal bonds usually have lower yields because they are tax-exempt.

65
Q

How is the yield difference between tax-exempt and Treasury securities measured?

A

As a yield ratio, the yield on a tax-exempt security as a percentage of a comparable Treasury security.

66
Q

How does the pure expectations theory explain a rising yield curve?

A

It reflects the market’s expectation that future short-term interest rates will rise.

67
Q

What impact does liquidity have on the yield spread between two issues?

A

Greater liquidity generally reduces the yield spread due to easier trading and higher demand.

68
Q

How does the liquidity preference theory justify an upward sloping yield curve?

A

Investors demand a premium for holding longer-term bonds due to greater interest rate risk.

69
Q

Why might a swap spread be viewed as an important measure in global markets?

A

It reflects the premium market participants must pay above risk-free Treasury rates to access funding in the swap market.

70
Q

How do embedded options affect yield spreads?

A

Securities with issuer-favorable options require a higher yield spread, while those with investor-favorable options have a lower spread.

71
Q

What does the market segmentation theory suggest about interest rates within different maturity sectors?

A

Interest rates are determined by the supply and demand for funds within each independent maturity sector.

72
Q

How might a synthetic fixed-rate asset be created using an interest rate swap?

A

By swapping floating-rate payments for fixed-rate payments through an interest rate swap agreement.

73
Q

What is the relationship between swap spreads and credit risk in the financial system?

A

A wider swap spread indicates higher credit risk or systemic financial stress.

74
Q

How does the economic outlook affect the relationship between credit spreads and Treasury yields?

A

Credit spreads widen during economic downturns as investors seek safer Treasury securities, and narrow during economic expansions.

Fixed Income (5 decks)

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