Fix Incomes

Question 1

retire the bond

Answer 1

It refers to a buyback of bonds previously sold. In other words, it means a bond issuer has paid off the debt represented by the bonds.

Question 2

I’m long duration

Answer 2

“The duration of my portfolio is longer than average, meaning I’m betting that interest rates will fall and bond prices will rise.”

Excerpt From: “Security Analysis.” - Howard Mark

Question 3

I’m short spreads

Answer 3

“I believe the spread by which the yield on high yield bonds exceeds the yield on Treasury bonds—which results from perceived corporate credit risk—will increase in the future. That means the prices of risky bonds will fall.”

Excerpt From: “Security Analysis.” - Howard Mark

Question 4

I’m long credit

Answer 4

“My bond portfolio is overweighted in corporate bonds relative to government bonds, meaning I think positive trends in economic growth and corporate profits will cause corporates to outperform.”

Excerpt From: “Security Analysis.” - Howard Mark

Question 5

I trade rates

Answer 5

“I deal in government debt and anything related to it, such as inflation-indexed bonds, futures, forwards, options, swaps, and swaptions”

Excerpt From: “Security Analysis.” - Howard Mark

Question 6

bonds

Answer 6

securities that promise regular payments until a final payment date

Question 7

maturity date

Answer 7

the final payment date of a bond

Question 8

coupons

Answer 8

the promise interest payments of a bond
Note: coupons are paid throughout the life of a bond

Question 9

face value or principal

Answer 9

the amount of the bond pays back at maturity. This is in addition to final coupon that is paid at maturity

Question 10

bond certificate

Answer 10

the documents describing the coupon rate, face value, and maturity date of a bond

Question 11

zero coupon bonds

Answer 11

a type of bond that pays no coupon (no cash flow), and it only pays the principal at maturity

Question 12

Coupon Formula

Answer 12

coupon = (coupon rate * face value) / number of payments per year

Question 13

issuing
issuer

Answer 13

the act of selling a security for the first time
the entity that issues the security

Question 14

treasury bills
what is the other common nam for it?

Answer 14

bond issued by the US government with a maturity of 1 year or less
T-bills

Question 15

treasury notes

Answer 15

bonds issued by the US government with a maturity of 2 -10 years

Question 16

treasury bonds

Answer 16

bonds issued by the US government with a maturity of 10-30 years

Question 17

what are the characteristic of payment for treasury notes & bonds?

Answer 17

they pay semi-annual coupons

Question 18

yield to maturity (yield)

Answer 18

the rate of return at which the cash flows of the bond must be discounted to obtain the current bond price

Question 19

T or F: yield is the IRR of the bond

Answer 19

True

Question 20

strips

Answer 20

zero coupon bonds based on US government bonds
I.e: a brokerage house buys a 30-yr bond, and create 60 securities based on semi-annual coupons and 1 based the principal

Question 21

Bond Price Formula

Answer 21

𝑃𝑟𝑖𝑐𝑒 = 𝐶𝑜𝑢𝑝𝑜𝑛/ (1+y) + ⋯ + 𝐶𝑜𝑢𝑝𝑜𝑛 + 𝐹𝑎𝑐𝑒𝑉 / (1+y)^T
P = Price
y = Yield (or IRR of the bond)
T = Time to Maturity
FaceV = Face Value + Final Coupon

Question 22

what does the yield curve represent?

Answer 22

The Yield Curve (from STRIP prices) represents the annual rates of return an investor can obtain by investing government securities of different maturities

Question 23

risk free rate

Answer 23

the yield on government bonds

Question 24

why bond price and its yield have to move in opposite direction?

Think about the mathematic equation implication

Answer 24

To have the coupon a constant value

Question 25

T or F: When bond price increases, the yield also increases

Answer 25

F - bond price and yield move in opposite direction

Question 26

How does the coupon rate differ from the bond yield?

Answer 26

1) The coupon rate is a constant value, which is written on the bond certificate
2) bond yield changes according to the bond prices movement

Question 27

Describe the related relationships among the bond price, face value, coupon rate and yield:
1) above par
2) below par

Answer 27

1) when bond price is traded above its face value ($100), and yield is smaller than the coupon rate
2) when bond price is traded below its face value ($100), and yield is greater than the coupon rate

Question 28

why yields on the government bond are so important?

Answer 28

because analysts use them as an opportunity cost of capital when valuing bonds

Question 29

Consider the face value of a bond is $100 but has different coupon rate 2% vs 4%, which one should you buy?

Answer 29

Unknown because we don’t know the price of the each bond. However, given the same risk, if the bond price is traded below par (<$100), then that bond can be a good investment as its yield is also higher than its coupon rate

Question 30

Consider two different bonds with each coupon rate 2% vs 4%, and the 2% rate bond is priced at $99 (below par), what is the most important factor to take into account to calculate the price of 4% rate bond?

Answer 30

the yield of the 2% rate bond (3.03%) as an opportunity cost of capital for not invest in it

Question 31

T or F: Different coupon rates bond can’t have the same yield?

Answer 31

F - they can because yield also depends on the bond prices

Question 32

Consider two different bonds with each coupon rate 2% vs 4%, and the 2% rate bond is priced at $99 (below par), calculate the price of 4% bond. Will it be a good investment if it is traded below this price?

Answer 32

1) Using excel to find the opportunity cost of capital from 2% coupon bond, you can find the bond price (NPV) of 4% is at $100.94
2) Yes

Question 33

In market, what is the mathematically true cause of the bond price fluctuation?

Answer 33

the variable cash flows generated by the bond

Question 34

Consider the face value of a bond is $100 but has different coupon rate 2% vs 4%, which one has a higher return?

Answer 34

Neither because the rate of return (yield) or IRR is the same for both

Question 35

Yield of a Strip

Answer 35

NPV = 100/ (1+y)^t
–> y = (100/NPV)^1/t -1

Question 36

1) Calculate the yield of a strip with maturity of five years that is trading at $94.38
2) What does the yield mean for this strip?

Answer 36

1) Using excel, its 1.16%
2) It means that the annual return for this strip is 1.16% until you get the full face value (principal) of $100 in year 5

Question 37

Can the yield curve slope down?

Answer 37

Yes - in this case, its called inverted yield curve

Question 38

T or F: You can use the risk free rate as the opportunity cost of capital to value a risky project (bond)

Answer 38

F - We need an additional risk premium to compensate the investor

Question 39

the inverted yield curve happen if?

Answer 39

if the short-term bonds have higher yield than the long-term bonds

Question 40

when does the inverted yield curve happen

Answer 40

when short-term rates increase rapidly -> the opportunity cost higher -> investor dump short-term bonds -> higher yield than long-term bonds

Question 41

why holding longer-term bonds can be more risky than short-term bonds

Answer 41

because a company can run into a risk of default when future is far ahead

Question 42

T or F. Bonds payout are made after corporation tax has already been deducted

Answer 42

F
Bonds payout are made before corporation tax has already been deducted.

Question 43

why can’t a loan be called a bond?

Answer 43

because loan is not tradeable