Fix Incomes Flashcards
retire the bond
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.
I’m long duration
“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
I’m short spreads
“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
I’m long credit
“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
I trade rates
“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
bonds
securities that promise regular payments until a final payment date
maturity date
the final payment date of a bond
coupons
the promise interest payments of a bond
Note: coupons are paid throughout the life of a bond
face value or principal
the amount of the bond pays back at maturity. This is in addition to final coupon that is paid at maturity
bond certificate
the documents describing the coupon rate, face value, and maturity date of a bond
zero coupon bonds
a type of bond that pays no coupon (no cash flow), and it only pays the principal at maturity
Coupon Formula
coupon = (coupon rate * face value) / number of payments per year
issuing
issuer
the act of selling a security for the first time
the entity that issues the security
treasury bills
what is the other common nam for it?
bond issued by the US government with a maturity of 1 year or less
T-bills
treasury notes
bonds issued by the US government with a maturity of 2 -10 years
treasury bonds
bonds issued by the US government with a maturity of 10-30 years
what are the characteristic of payment for treasury notes & bonds?
they pay semi-annual coupons
yield to maturity (yield)
the rate of return at which the cash flows of the bond must be discounted to obtain the current bond price
T or F: yield is the IRR of the bond
True
strips
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
Bond Price Formula
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
what does the yield curve represent?
The Yield Curve (from STRIP prices) represents the annual rates of return an investor can obtain by investing government securities of different maturities
risk free rate
the yield on government bonds
why bond price and its yield have to move in opposite direction?
Think about the mathematic equation implication
To have the coupon a constant value
T or F: When bond price increases, the yield also increases
F - bond price and yield move in opposite direction
How does the coupon rate differ from the bond yield?
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
Describe the related relationships among the bond price, face value, coupon rate and yield:
1) above par
2) below par
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
why yields on the government bond are so important?
because analysts use them as an opportunity cost of capital when valuing bonds
Consider the face value of a bond is $100 but has different coupon rate 2% vs 4%, which one should you buy?
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
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?
the yield of the 2% rate bond (3.03%) as an opportunity cost of capital for not invest in it
T or F: Different coupon rates bond can’t have the same yield?
F - they can because yield also depends on the bond prices
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?
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
In market, what is the mathematically true cause of the bond price fluctuation?
the variable cash flows generated by the bond
Consider the face value of a bond is $100 but has different coupon rate 2% vs 4%, which one has a higher return?
Neither because the rate of return (yield) or IRR is the same for both
Yield of a Strip
NPV = 100/ (1+y)^t
–> y = (100/NPV)^1/t -1
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?
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
Can the yield curve slope down?
Yes - in this case, its called inverted yield curve
T or F: You can use the risk free rate as the opportunity cost of capital to value a risky project (bond)
F - We need an additional risk premium to compensate the investor
the inverted yield curve happen if?
if the short-term bonds have higher yield than the long-term bonds
when does the inverted yield curve happen
when short-term rates increase rapidly -> the opportunity cost higher -> investor dump short-term bonds -> higher yield than long-term bonds
why holding longer-term bonds can be more risky than short-term bonds
because a company can run into a risk of default when future is far ahead
T or F. Bonds payout are made after corporation tax has already been deducted
F
Bonds payout are made before corporation tax has already been deducted.
why can’t a loan be called a bond?
because loan is not tradeable
