Fixed Income

Question 1

What is the Coupon Rate

Answer 1

Coupon / FV

Question 2

What is the Bond Yield

Answer 2

Coupon / Price

Question 3

What is the YTM

Answer 3

Rate that makes the PV of Coupons = Price

Question 4

How do Bond prices relate to rates?

Answer 4

Bond prices are inversely correlated to interest rates

Question 5

What is the Duration of a Bond?

Answer 5

The weighted average life of the bond before complete repayment

Question 6

What is the Modified Duration?

Answer 6

The sensitivity of the Bond Price to a 1% change in interest rates

Question 7

What is the Basis Point Value of a Bond?

Answer 7

Sensitivity of Bond Price to a 0.01% (1bp) change in interest rate. If interest rates go up by 0.01%, how much does the bond go down (per 100$)

Question 8

What is the Convexity of a Bond?

Answer 8

Second derivative of the sensitivity of prices to interest rate changes.

Question 9

Is Convexity good or bad for a Bond Price? Why?

Answer 9

More convexity -> Higher price. Because of risk-reward. Think of relationship between price and rates. With higher convexity, when rates rise, the prices don’t fall as much. Whereas when rates go down, the price increases more.

Question 10

Can we take advantage of the fact that there are more convex bonds?

Answer 10

Not really, usually the convexity is priced in.

Question 11

How does Maturity relate with Convexity?

Answer 11

Longer Maturity, higher convexity. Think that with longer maturity, changes in rates affect the bond price less. (It is more spread out)

Question 12

How does Coupon relate to Convexity?

Answer 12

Lower Coupon, higher convexity.

Question 13

What is the carry of an asset?

Answer 13

The benefit from simply holding that asset

Question 14

Carry formula

Answer 14

Yield - rate

Question 15

What is the Roll Down of an asset

Answer 15

The return resulting from the passage of time, if rates remain the same. As time to maturity becomes smaller, if YC is normal, assets will be discounted at lower rates.

Question 16

How is Fixed Income Arbitrage usually applied?

Answer 16

Trading 2 or more points of the yield curve.

Question 17

Important when developing Fixed Income Arbitrage strategies

Answer 17

Calibrate by Duration/BPV

Question 18

What is the explanation for a Mildly Positive Slope of the YC?

Answer 18

Liquidity preferences (better to hold an asset now)

Question 19

What is the explanation for a Steep/Flat/Inverted Slope of the YC?

Answer 19

Inflation/Growth expectations

Question 20

What is the explanation for Bumps/Anomalies in the Slope of the YC?

Answer 20

Market Segmentation

Question 21

Explanations for Zero/Negative rates

Answer 21

Demand-Supply imbalances

Question 22

What is a Bear Flattening?

Answer 22

YC flattens and ST rates lead

Question 23

What is a Bull Flattening?

Answer 23

YC flattens and LT rates lead

Question 24

What a Bull Steepening?

Answer 24

YC steepens and ST rates lead

Question 25

What is a Bear Steepening?

Answer 25

YC steepens and LT rates lead

Question 26

What can cause a Bear Flattening?

Answer 26

ST rate increases

Question 27

What can cause a Bull Flattening?

Answer 27

Quantitative Easing

Question 28

What can cause a Bull Steepening?

Answer 28

ST rate cuts

Question 29

What can cause a Bear Steepening?

Answer 29

Expected Inflation

Question 30

What asset class should you hold in a Bear Flattening?

Answer 30

Cash. Rates up mean no bonds, also equities isn’t great because it destroys demand. Just hold cash. Think US Dollar during inflation.

Question 31

What asset class should you hold in a Bull Flattening?

Answer 31

Bonds. Rates down.

Question 32

What asset class should you hold in a Bull Steepening?

Answer 32

Gold. No yield, Fixed Income yielded 2%, now it yields 1%

Question 33

What asset class should you hold in a Bear Steepening?

Answer 33

Equities (hotter economy, higher growth rates). Bonds will get killed.

Question 34

Roll Down Formula:

Answer 34

MD x Change in Rate

Question 35

What position should an investor take in case of a steepening? Asset class is Bonds

Answer 35

Go long ST and short LT

Question 36

What does it mean to be Duration Neutral?

Answer 36

To not be sensitive to changes in interest rates

Question 37

How can we have a Duration Neutral strategy?

Answer 37

Adjust the ratios invested for the MDuration spread. Ex.: If we have an asset with MDuration 2, and the other with 1, then we should concentrate twice the weight on the MDuration = 1 asset

Question 38

What is the Actual P&L in a normal Fixed Income strategy

Answer 38

Real Mark-to-Market (difference in prices) + Carry