Fixed Income Flashcards
What is the Coupon Rate
Coupon / FV
What is the Bond Yield
Coupon / Price
What is the YTM
Rate that makes the PV of Coupons = Price
How do Bond prices relate to rates?
Bond prices are inversely correlated to interest rates
What is the Duration of a Bond?
The weighted average life of the bond before complete repayment
What is the Modified Duration?
The sensitivity of the Bond Price to a 1% change in interest rates
What is the Basis Point Value of a Bond?
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$)
What is the Convexity of a Bond?
Second derivative of the sensitivity of prices to interest rate changes.
Is Convexity good or bad for a Bond Price? Why?
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.
Can we take advantage of the fact that there are more convex bonds?
Not really, usually the convexity is priced in.
How does Maturity relate with Convexity?
Longer Maturity, higher convexity. Think that with longer maturity, changes in rates affect the bond price less. (It is more spread out)
How does Coupon relate to Convexity?
Lower Coupon, higher convexity.
What is the carry of an asset?
The benefit from simply holding that asset
Carry formula
Yield - rate
What is the Roll Down of an asset
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.
How is Fixed Income Arbitrage usually applied?
Trading 2 or more points of the yield curve.
Important when developing Fixed Income Arbitrage strategies
Calibrate by Duration/BPV
What is the explanation for a Mildly Positive Slope of the YC?
Liquidity preferences (better to hold an asset now)
What is the explanation for a Steep/Flat/Inverted Slope of the YC?
Inflation/Growth expectations
What is the explanation for Bumps/Anomalies in the Slope of the YC?
Market Segmentation
Explanations for Zero/Negative rates
Demand-Supply imbalances
What is a Bear Flattening?
YC flattens and ST rates lead
What is a Bull Flattening?
YC flattens and LT rates lead
What a Bull Steepening?
YC steepens and ST rates lead
What is a Bear Steepening?
YC steepens and LT rates lead
What can cause a Bear Flattening?
ST rate increases
What can cause a Bull Flattening?
Quantitative Easing
What can cause a Bull Steepening?
ST rate cuts
What can cause a Bear Steepening?
Expected Inflation
What asset class should you hold in a Bear Flattening?
Cash. Rates up mean no bonds, also equities isn’t great because it destroys demand. Just hold cash. Think US Dollar during inflation.
What asset class should you hold in a Bull Flattening?
Bonds. Rates down.
What asset class should you hold in a Bull Steepening?
Gold. No yield, Fixed Income yielded 2%, now it yields 1%
What asset class should you hold in a Bear Steepening?
Equities (hotter economy, higher growth rates). Bonds will get killed.
Roll Down Formula:
MD x Change in Rate
What position should an investor take in case of a steepening? Asset class is Bonds
Go long ST and short LT
What does it mean to be Duration Neutral?
To not be sensitive to changes in interest rates
How can we have a Duration Neutral strategy?
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
What is the Actual P&L in a normal Fixed Income strategy
Real Mark-to-Market (difference in prices) + Carry
