Fin 4319-Record B8

Question 1

When will a callable bond be called away?

Answer 1

how far the interest rate is below the coupon rate of the bond

Question 2

What is out of the money?

Answer 2

there is a low probability of the callable bond being called.

Question 3

What is deep out of the money?

Answer 3

there is a very low probability of the callable bond being called.

Question 4

Who has the option to call a callable bond?

Answer 4

The issuer has the option to call so it’s not the investor. The issuer pays back the money earlier, and you the investor gets the money back earlier. It’s the bad for the investor because interest rates have fallen, and may have have reinvestment risk.

Question 5

in general will a callable bond price be traded at a lower price or higher?

Answer 5

lower price

Question 6

callable bond suffers from negative convexity

Answer 6

a

Question 7

discuss behavior credit spreads in the business cycle

Answer 7

if you thought cycle is going to strengthen or weaken, how would you alter the duration of your portfolio or the credit risk of your portfolio (default free treasuries, or junk bonds).

Question 8

what are Moody’s investment grade bonds?

Answer 8

baa and above are investment grade

Question 9

what are Moody’s junk bonds?

Answer 9

below baa are junk bonds

Question 10

what are junk bond mutual funds called?

Answer 10

high yield bond fund

Question 11

why do mutual funds create high yield bond funds?

Answer 11

some financial institutions are required by law to only own investment grade bonds so they could be mispriced. the mutual fund companies package the junk bonds together to sell them to investors for high yield.

Question 12

For a company to be allowed to issue a bond, the company had to be investment grade quality, so where did Junk Bonds come from?

Answer 12

Investment grade companies were downgraded, also referred as fallen angels.

Question 13

What are the differences between new junk and old junk bonds?

Answer 13

New junk bonds have a lot of loan workout provisions written in the bond indenture (contract between bond purchaser and bond issuer. Everyone knows there’s a high risk of default so they create provisions in case they miss coupon payment.

Question 14

What are PIK (payment in kind) provisions?

Answer 14

If the company has a bad quarter they will pay the junk bond investor with securities. This means you will automatically extend a loan to them for missing a coupon payment. If the company missed several coupons that would trigger a lawsuit.

Question 15

what are loan workout provisions?

Answer 15

they are provisions written in new junk bonds that states when you may receive securities for missed payments instead of cash

Question 16

what are the differences in yields at each run of bond rating?

Answer 16

the higher the rating, the lower the yield, and the lower the rating the higher the yield.

Question 17

for the different bond ratings, are they a measure of absolute or relative default risk?

Answer 17

relative risk

Question 18

when you go into a recession, what happens to the default risk at every level of rating?

Answer 18

default risk increases during a downturn in the economy. Companies don’t usually go bankrupt in a strong economy.

Question 19

what information is provided by bond ratings?

Answer 19

Bond ratings are very slow to change so the rating may not reflect the current price. The bond market price is a faster measure of bond investment or junk status than the rating by the credit ratings companies. The bond issuer pays the rating agency to do the ratings.

Question 20

how do credit spreads move over the business cycle?

Answer 20

during recession the spread should widen. default risk goes up during recession. during recession people are less willing to take risk, maybe people will lose their jobs. rates fall during recession

Question 21

what kind of economic indicator are interest rates?

Answer 21

they are a lagging indicator

Question 22

how do tbills interest rates economic activity?

Answer 22

they are more volatile.. they rise faster and fall faster

Question 23

in a expansion the spread is tightened

Answer 23

rates on treasuries rise or fall faster than high grade corporates

Question 24

in a recession what yields do you get in junk bonds and treasuries

Answer 24

junk bond yields are highest and treasuries lowest. junk bonds are counter cyclicle

Question 25

in an expansion what yields do you get in junk bonds and treasuries?

Answer 25

junk bonds yields are lower and treasuries are higher

Question 26

What if you expect the economy to weaken unexpectedly?

Answer 26

You want to lengthen the duration of your portfolio.

Question 27

How do you make money when you expect the economy to weaken unexpectedly?

Answer 27

Buy treasuries, 
Don't buy junk bonds.
You want non-callable bonds.
Increase duration.
Increase credit quality

Question 28

How do you make money when you expect the economy to strengthen unexpectedly?

Answer 28

Shorten duration by buying high grade corporate bonds

Decrease credit quality by Buying junk bonds

Question 29

review 7, describe the relationship between duration and bond price sensitively

Answer 29

direct relationship, duration is the price of the bond