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CFA L3 > Fixed Income > Flashcards

Fixed Income Flashcards

1
Q

Which has higher convexity, bullet or barbell?

A

Barbell

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2
Q

What is bull steepener?

A

Short term interest rates will fall by more than long term rates

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3
Q

Bear steepener

A

Long term rates will rise by more than short term rates

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4
Q

Bear flattener

A

Short rates will rise more than long term rates

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5
Q

Bull flattener

A

Long term rates will fall by more than short term rates

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6
Q

Callable bond is combination of

A

Option free bond and a short call option

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7
Q

Putable bond combination of

A

Option free bond and long put option

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8
Q

Define rolling yield

A

Sum of coupon income and roll down return

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9
Q

Which portfolio has most modified duration?

A

Barbell

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10
Q

Which has least modified duration?

A

Bullet

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11
Q

G spread

A

Bonds ytm (-) interpolated ytm of 2 adjacent maturity on the run government bonds

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12
Q

Yield spread

A

Bonds ytm minus the ytm of closest on the run government bond

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13
Q

I spread

A

Bonds ytm minus maturity of interpolated swap fixed rate

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14
Q

Asw spread

A

Bonds fixed coupon minus the maturity interpolated sfr

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15
Q

Anchoring bias

A

The anchoring bias is the tendency of the mind to give disproportionate weight to the first information it receives on a topic: initial impressions, estimates, or data, anchor subsequent thoughts and judgments.

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16
Q

Asset liability management strategy

A

Asset–liability management strategies consider both assets and liabilities in the portfolio decision-making process.

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17
Q

What’s yield curve inversion

A

Yield curve inversion is an extreme version of flattening in which the spread between long-term and short-term yields-to-maturity falls below zero

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18
Q

What’s immunization

A

Immunization is the process of structuring and managing a fixed-income portfolio to minimize the variance in the realized rate of return and to lock in the cash flow yield (internal rate of return) on the portfolio

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19
Q

Rules of immunizing a single liability

A
  1. Initial portfolio market value (PVA) equals (or exceeds) PVL. (There are exceptions to this for more complex situations where the initial portfolio IRR differs from the initial discount rate of the liability.)
  2. Portfolio Macaulay duration matches the due date of the liability (D = DL).
  3. Minimize portfolio convexity (to minimize dispersion of asset cash flows around the liability and reduce risk to curve reshaping).
  4. Regularly rebalance the portfolio to maintain the duration match as time and yields change. (But also consider the tradeoff between higher transaction costs from morefrequent rebalancing versus the risk of allowing durations to drift apart.)
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20
Q

Rules of immunizing multiple liabilities

A
  1. Initial portfolio market value (PVA) equals (or exceeds) PVL. (There are exceptions to this for some situations where the initial portfolio IRR differs from the initial discount rate of the liability.)
  2. Portfolio and liability basis point values match (BPV = BPVL)
  3. Asset dispersion of cash flows and convexity exceed those of the liabilities. (But not by too much, in order to minimize structural risk exposure to curve reshaping).
  4. Regularly rebalance the portfolio to maintain the BPV match of A and L as time and yields change.
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21
Q

Covered bonds

A

Senior debt obligations of a commercial Bank backed by a pool of mortgages or loans made by the bank.

The key feature of a covered bond is that it provides dual recourse: investors have a claim on both the issuer and the underlying pool of assets if the issuer defaults.

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22
Q

If fair CDS spread is above standardized fixed coupon

A

Protection buyer needs to make upfront premium payment to the protection seller at initiation of contract

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23
Q

Structural models

A

Structural credit models
use market-based variables to estimate the market value of an issuer’s assets and the volatility of asset value. The likelihood of default is defined as the probability of the asset value falling below that of liabilities.

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24
Q

Reduced form models

A

Look for relationship between macroeconomic conditions and individual characteristics of a borrower such as financial ratios to infer default intensity for a bond issuer

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25
Q

Smart beta

A

Identifying relatively simple definable rules that can be followed to add value

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26
Q

Contingent immunization

A

It is a hybrid active/passive strategy that requires a significant surplus

27
Q

Asset liability management

A

Means strategies that consider assets in relation to liabilities

28
Q

Asset driven investing

A

Takes the assets as a given and manages or adjusts the liabilities in relation to those assets

29
Q

Type 1, 2, 3 and 4 liabilities

A
  • known future amounts and payout dates
  • known future amounts but uncertain payout dates
  • uncertain future amounts but known payout dates
  • unknown everything
30
Q

Repurchase agreement (repos)

A

An explicit way to borrow funds that could be used for leveraging. A securities owner sells a security for cash and simultaneously agrees to buy it back at a specified future date

31
Q

credit spread volatility and interest rate volatility

A

more in investmnent grade bonds

32
Q

CDS long short strategy

A

Buying protection on issuers where spreads are expected to widen relative to other issuers and shorting vice versa

33
Q

positive key rate duration significance

A

manager expects interest rates to rise

34
Q

Random interesting fact

A

If the yield curve is upward-sloping, buying bonds with a maturity beyond the investment horizon offers a total return (higher coupon plus price appreciation)
greater than the purchase of a bond with maturity matching the investment horizon if the curve remains static.

35
Q

Bottom up credit strategies for credit strategies

A

Bottom-up credit strategies include the use of financial ratio analysis,
reduced form credit models (such as the Z-score model), and structural credit models, including Bloomberg’s DRSK mode

36
Q

Fixed income is a good diversifier

A

has low correlation with equity

37
Q

OAS spread

A

OAS is like the extra reward (in terms of higher interest or yield) you get from a bond compared to a risk-free bond (like a government bond) after accounting for the uncertainty caused by options built into the bond.

38
Q

Duration neutral flattening strategy

A

A duration-neutral flattening trade involves taking opposite positions in short-term and long-term bonds such that the net duration exposure is zero, but the portfolio is positioned to benefit from changes in the slope of the yield curve

39
Q

bottom up approach

A

The bottom-up approach involves selecting the individual bonds or issuers that the investor views as having the best relative value from among a set of bonds or issuers with similar characteristics (usually the same industry and often the same country of domicile).

40
Q

Top down approach

A

The top-down approach involves the investor formulating a view on major macroeconomic trends, such as economic growth and corporate default rates, and then selecting the bonds that the investor expects to perform best in a given environment.

41
Q
A
42
Q

what is a covered call?

A

A covered bond is a type of debt security issued by a financial institution, such as a bank, and backed by a pool of high-quality assets (called the “cover pool”). Covered bonds are designed to be very safe investments because bondholders have a dual claim:

On the issuing institution (the bank or financial institution).
On the cover pool of assets, in case the issuing institution defaults.
43
Q

Multiple liability immunization

A

The two requirements to achieve immunization for multiple liabilities are for the money duration (or BPV) of the asset and liability to match and for the asset convexity to exceed the convexity of the liability.

44
Q

youve got this buddy

A

I have complete trust on you

45
Q

In LDI, certain risks like longevity and inflation risks are not included

A
46
Q

credit cycle charachteristics - Early expansion (recovery)

A

Economic Activity - Stable
Corporate Profitability - Rising
Corporate Leverage - Falling
Corporate Defaults - Peak
Credit Spread Level - Stable
Credit Spread Slope -Stable for high grade, inverted for low ratings

47
Q

CCC - Late expansion

A

Economic Activity - Accelerating
Corporate Profitability - Peak
Corporate Leverage - Falling
Corporate Defaults - Falling
Credit Spread Level - Stable
Credit Spread Slope -Steeper for both higher
and lower ratings

48
Q

CCC - Peak

A

Economic Activity - Decelerating
Corporate Profitability - Stable
Corporate Leverage - Rising
Corporate Defaults - Stable
Credit Spread Level - Rising
Credit Spread Slope - Steeper for both higher
and lower ratings

49
Q

CCC - Contraction

A

Economic Activity - Declining
Corporate Profitability - Falling
Corporate Leverage - Peak
Corporate Defaults - Rising
Credit Spread Level - Peak
Credit Spread Slope Flatter for high grade, inverted
for low ratings

50
Q

Reduced form models

A

Reduced form models solve for default intensity,
or the POD over a specific time period, using observable company-specific variables such as financial ratios and recovery assumptions as well as macroeconomic variables, including economic growth and market volatility measures.

51
Q

what is a payer option on CDS index?

A

Option buyer pays premium for right to buy protection (“pay” coupons) on CDS index contract at a future date

52
Q

what is a receiver option on CDS index?

A

Option buyer pays premium for right to sell protection (“receive” coupons) on CDS index contract at a future date

53
Q

Smart Beta

A

Smart Beta os a middle ground between regular index investing (which is super simple) and active investing (where fund managers try to beat the market with complex strategies).

Smart Beta Investing: Instead of just following size, smart beta funds follow a set of rules to pick and weight investments differently. These rules are based on patterns or traits (called “factors”) that have worked well in the past. For example:

Pick cheap stocks (value).

Focus on stable, profitable companies (quality).

Look for stocks that go up steadily (low volatility).

54
Q

Role of fixed income securities in a portfolio

A
  • Diversification benefits
  • Benefits of regular cash flows
  • Inflation hedging potential
55
Q

Portfolio dispersion

A

Portfolio dispersion tells you how spread out those payment times are compared to the average waiting time (called duration).

56
Q

Value of the embedded call option

A

Will increase as volatility rises, reducing the value of the bond versus a similar option-free bond, thus causing nominal spreads to increase.

57
Q

MBS bond

A

An MBS is a bond with an embedded short call option. A short call option has negative convexity. Adding more MBS to a portfolio will decrease the
convexity of the portfolio and thus result in a smaller (not greater) benefit from a large change in interest rates.

58
Q

What is a swaption collar

A

Combines buying a 3.50% receiver swaption and writing a 5.00% payer swaption to create a zero-cost structure.

59
Q

what is a receiver swaption?

A

The plan buys an option to enter into a 30-year receive-fixed interest rate swap at a strike rate of 3.50%

60
Q

What are the different risks in liability driven investing

A
  • model risk
  • spread risk
  • counterparty credit risks
  • asset liquidity risk
61
Q

Cash flow matching strategy

A

Cash flow matching involves aligning the cash flows from an investment portfolio to meet specific liabilities. This strategy ensures that the timing and amount of cash flows from investments perfectly offset the liability obligations.

62
Q

Duration matching strategy

A

Duration matching aligns the duration of an investment portfolio with the duration of the liabilities. This minimizes the impact of interest rate changes on the portfolio’s ability to meet liabilities.

63
Q

advantages and disadvantages of cash flow matching

A

Advantages
- Perfect Liability Coverage: Eliminates reinvestment risk since cash flows directly match liabilities.
- Simplicity: Once set, minimal adjustments are needed unless liabilities change.

Disadvantages
- high cost
- constrained universe

64
Q

advantages and disadvantages of duration matching strategy

A
  • hedging against interest rate changes
  • flexible
    Disadvantages
  • Imperfect liability coverage
  • Complexity

CFA L3 (11 decks)

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