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Fixed Income Flashcards

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1
Q

What does 2y1y means?

A

Borrow for 1 year after 2 years

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2
Q

What happens to FR curve when SR curve is -
a) flat
b) upward sloping
c) downward sloping

A

a) FR equal to SR
b) FR above SR
c) FR below SR

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3
Q

What is par rate?

A

The coupon rate for bonds of various maturities that would result in bond prices equal to their par values.

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4
Q

If SR evolves as predicted FR then bonds of all maturity will realise a one period return equal to one period-
a) SR
b) FR

A

SR

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5
Q

As per active portfolio manager what happens when-
a) Implied FR is higher than actual SR in future
b) Implied FR is lower than actual SR in future

A

a) Market appears to be discounting future CF at high rate. Buy bond
b) Market discounting future CF at low rate. Sell bond

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6
Q

What is riding the yield curve?

A

Instead of holding short maturity bond, holding long maturity bond when yield curve is upward sloping will realise excess return.

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7
Q

Which curve is important benchmark for credit markets and for market participants (wholesale banks)?

A

For credit markets - Spot rate curve
For wholesale banks - Swap rate curve
since swap curve is not regulated thus is more comparable.

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8
Q

What is plain vanilla swap?

A

One party makes payment on fixed rate and receive floating rate.

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9
Q

What does higher I spread signifies?

A

Higher the I spread, riskier the bond.

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10
Q

What is the most important factor in affecting treasury return?

A

Change in level of interest rates,.

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11
Q

What does unbiased expectations theory/pure expectations theory suggests?

A

FR is unbiased predictor of future SR.
Investor is risk neutral.

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12
Q

What does segmented market theory (proper balance) suggests?

A

The shape of the yield curve is result of SS and DD of funds in different markets. Each maturity is essentially unrelated to other maturity.

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13
Q

What shift does effective duration and key rate duration measures?

A

a) Effective duration - Parallel shift
b) Key rate duration - Non parallel - shaping risk

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14
Q

What does curvature movement means?

A

If increasing =, it states that short and long term interest rate will increase whereas intermediate rate do not change.

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15
Q

Which spread is a measure of counterparty risk and signifies credit risk?

A

Ted spread

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16
Q

What is LIBOR OIS spread?

A

libor OIS spread rate assumes 0 credit risk. It is a good indicator of money market securities.

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17
Q

What is Secured Overnight Financing Rate?

A

SOFR or overnight cash borrowing rate collateralised by US treasuries is a volume weighted index of all qualified repo market transactions on a given day and is influenced by DD and SS conditions in secured funding markets.

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18
Q

True or False
If the yield curve is not flat, the coupon payments will not be reinvested at the YTM and the expected return will differ from the yield.

A

True

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19
Q

True or False
Z-spread is the most appropriate to use to value bonds with embedded options

A

False, it is not appropriate

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20
Q

Which theory can be used to explain almost any yield curve shape.

A

The preferred habitat theory

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21
Q

Bootstrapping entails-
a) forward substitution
b) backward substitution

A

Forward substitution

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22
Q

What is Ho Lee model?

A

An arbitrage free valuations model, The model assumes constant volatility and produces a symmetrical (normal) distribution of future rates.
Derived using the relative pricing concepts of the Black-Scholes model, this model assumes that changes in the yield curve are consistent with a no-arbitrage condition.
The ability to calibrate arbitrage-free models to match current market prices is one advantage of arbitrage-free models over the equilibrium models.

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23
Q

What is Cox Ingersoll model and Vasicek Model?

A

The Cox-Ingersoll-Ross (CIR) model and the Vasicek model, are both single-factor models. The single factor in the CIR and Vasicek models is the short-term interest rate.
The difference from the CIR model is that volatility in Vasicek model does not increase as the level of interest rates increases (i.e., volatility is constant). The main disadvantage of the Vasicek model is that the model does not force interest rates to be nonnegative.

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24
Q

What is Kalotay Williams Faboozi model?

A

The Kalotay-Williams-Fabozzi (KWF) model does not assume mean reversion and, like the Ho-Lee model, assumes constant volatility and a constant drift.
the KWF model assumes that the short-term rate is lognormally distributed

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25
Q

What is Gauss+ multifactor model?

A

Gauss+ is a multifactor model that incorporates short-, medium-, and long-term rates, where the long-term rate is designed to be mean reverting and depends on macroeconomic variables. Medium-term rates revert to the long-term rate, while the short-term rate is devoid of a random component—consistent with the role of the central bank controlling the short-term rate.

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26
Q

True or False?
The market price of callable Bond with no protection period cannot exceed its par value (callable value).

A

True

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27
Q

Binomial Interest rate tree framework?

A

It is a lognormal model with two equally likely outcome.

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28
Q

What is the process of calibration of binomial interest rate tree?

A

a) forward rates are 2 SD apart.
b) midpoint of 2 interest rates is implied one period FR for that period.

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29
Q

Which model to calculate value of embedded options is best?

A

Binomial interest rate tree

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30
Q

How is interest rate volatility in binomial tree estimated?

A

Using historical rate volatility or observed market price from interest rate derivatives.

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31
Q

What is monte carlo forward rate substitution? For which securities is it suitable?

A

It uses pathwise valuation. Suitable for mortgage backed securities.
It has path dependent CF on account of embedded options.

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32
Q

True or False
Binomial Tree backward induction process is appropriate for securities with path dependant CF.

A

False, it is inappropriate

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33
Q

How is valuation of strip of bonds computed?

A

It is done on SR calculated from par rates

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34
Q

What is drift adjusted calibration model?

A

The calibration process entails adding (subtracting) a constant to all rates when the value obtained from the simulated paths is too high (too low) relative to market prices.

35
Q

What is estate put bond?

A

It includes a provision that allows heirs of investor to put the bond back to the issuer upon death of investor. the value of this option is inversely related to investor life expectancy.

36
Q

How interest rate volatility effects value of callable bond and putable bond?

A

Call and put both increases with volatility.
Hence callable bond will decrease and putable will increase with increase in volatility.
Since investor is short the call option and long the put option.

37
Q

How level and shape of yield curve effects value of callable bond and putable bond?

A

The value of call option is lower when yield curve is upward sloping. vice versa for put option.

38
Q

HIgher the OAS implies-
a) cheaper the bond
b) costlier the bond

A

a) cheaper the bond. Undervalued

39
Q

What are bermudian options?

A

Right to exercise bonds at specified date on or before expiry.

40
Q

How interest rate volatility affect OAS ?

A

High volatility implies low value of callable bond, hence OAS will also be lower.
High volatility implies high value of putable bond, hence OAS will also be higher.
Vice Versa

41
Q

Which type of relationship is there between YTM and Bond price?

A

Convex relationship which states that due to 1% change in YTm, % increase is more than % decrease. Hence, acting as a friend.

42
Q

Effective duration of floating bond?

A

Time in years to next reset.

43
Q

Which bond has the lowest convexity?
a) callable
b) putable
c) Straightj

A

Callable bond has negative convexity at low rates and positive convexity at high rates.
Since putable bond has maximum postive convexity.

44
Q

What happens to the conversion ratio when company pays dividend in excess of threshold limit?

A

Conversion ratio is adjusted upward.

45
Q

What happens to convertible bond when value of common stock-
a) Remains stable
b) Decreases
c) Increases

A

a) Return on bond may exceed stock due to coupon receipts
b) The straight value of bond limits downside risk
c) Bond will underperform the stock due to conversion premium

46
Q

What is common stock equivalent or busted convertible?

A

When price of stock falls so low, that call option expires out the money and value of convertible bond acts as straight bond.

47
Q

Which side duration do we capture for-
a) Straight bond
b) Bond with embedded options?

A

a) Two sided duration
b) One side duration

48
Q

True or False
When call option is in the money, it will have higher one sided up duration than down duration

A

True

49
Q

Which partial rate duration is most important for the following-
a) Callable bond with low coupon
b) Straight bond
d) Putable bond with low coupon

A

a) Probability of being called is low thus has highest key rate duration and maturity rate is important
b) Maturity rate is important and all other durations are 0.
c) Probability of being called is high, time to exercise rate is more important.

50
Q

What happens to call option and put option when upward sloping yield curve flattens?

A

Value of call option increases and put option decreases.

51
Q

What happens if estimated hazard rate is less than risk neutral probability?

A

This means that market has priced in higher credit risk in bond, i.e. bond is undervalued

52
Q

What is the credit quality curve for-
a) Investment grade bond
b) non - Investment grade bond

A

a) Upward or flat
b) Steeper or inverted

53
Q

The issuer rating for a company in credit rating is generally for which which type of debt?

A

Senior unsecured debt.
Ratings on other classes of debt is done by notching.

54
Q

Credit migration reduced expected return due to?

A

The probability of rating is not symmetrical. I.e. increase in credit spread is much larger for downgrade than is decrease in spread for upgrade.

55
Q

What is structural model?

A

Structural model is BSM option model. Model is based on structure of company’s balance sheet.
Tells why company defaults. i,e, endogenous
Requires inside information known to company management

56
Q

What is reduced form model?

A

They tell when company defaults. I.e. exogenous.
Default intensity is estimated using regression analysis on publicly available data & macroeconomic variables. So it directly reflects the business cycle in credit risk measure.

57
Q

What is covered asset backed security?

A

It has recourse right as well as it is backed by collateral pool.

58
Q

Which approach for credit analysis of asset backed securities is best suited for -
a) Short term Granular + homogenous
b) Medium term granular + homogenous
c) Descrete + Non granular

A

a) Statiscal based approach
b) Portfolio based approach
c) Individual loan level - eg. collateralized loan obligation

59
Q

What type of relationship is there between credit spread and benchmark rates over the business cycle?

A

Counter cyclical relationship,
A strong economic climate is associated with higher benchmark yields with lower credit spreads.

60
Q

What are soft and hard bullet covered bonds?

A

In the event the financial institution sponsor misses a payment, a soft or a hard bullet may be triggered. In the case of soft-bullet covered bonds, the maturity date of the bond is extended up to one year and all payments are not immediately due. In the hard-bullet covered bonds, the payments are accelerated.

61
Q

Which party buys the CDS?

A

The party which longs the credit risk or the protection seller.

62
Q

Is restructuring a credit even in US?

A

No

63
Q

What does monetising a position means?

A

It refers to closing a position in market.

64
Q

How is the credit spread when there is greater probability of default in earlier years or there is near term financial stress in market?

A

Downward sloping

65
Q

Naked CDS

A

You have bought a protection but do not have bond. Common for speculator

66
Q

Long short trade

A

Investor purchases protection on one reference entity while selling protection on another reference entity.

67
Q

Curve trade

A

It is long short trade type, where investor buy and sells protection on same reference entity but with different maturities.

68
Q

Curve Steepening Trade

A

When investor believes that short term is better than long term for reference entity, he will sell protection/ long short term and buy protection for long term.

69
Q

Curve flattening trade

A

When investor believes that Long term is better than short term for reference entity, he will buy protection/ short short term and sell protection for long term.

70
Q

Basis Trade

A

Attempt to exploit difference in credit spread between bond market and CDS market.

71
Q

What position should be taken in basis trade in case of leveraged buyout?

A

Buy protection and buy company stock.

72
Q

True or false-
Hazard rate affects both the premium leg as well as the protection leg in a CDS.

A

True

73
Q

On which type of debt is single name CDS generally written? When will it earn?

A

Senior unsecured obligation. It earns when credit spread widens.

74
Q

How many securities are there in-
a) investment grade
b) non investment grade

A

a) 125
b) 100

75
Q

How is index CDS pricing done?

A

Pricing of index CDS depends on correlation of defaults amongst the entities in index. higher the r higher the credit spread.
It earns when spread narrows.

76
Q

Tranche CDS

A

It covers multiple bond but losses are covered only up to a specified limit.

77
Q

In expectation of high rate of interest, in which duration bond will investor prefer to invest?

A

Short duration bonds.

78
Q

What is bond excess premium or term/duration premium?

A

Excess of return by investing in long duration bond over one year bond.

79
Q

What is bearish flattening?

A

During economic expansions, to combat rising inflation, central banks may raise short-term rates, leading to a bearish flattening of the yield curve.

80
Q

What is Bullish Steepening?

A

During recessionary times, central banks may reduce shortterm rates, leading to a bullish steepening

81
Q

What is the market segmentation theory of interest rates?

A

The government’s choice of maturity when issuing new securities affects the supply (and yield) of bonds in those maturity segments. An increase in offerings in a specific segment of the market increases the supply and increases the yield in that segment

82
Q

What is bullish flattening of yield curve?

A

During periods of market turmoil, a flight to safety may reduce long-term government bond yields, resulting in a bullish flattening of the yield curve.

83
Q

True or False
Investors with long-only mandates, an investor that expects a bullish flattening of the yield curve may rotate out of a bullet portfolio and into a barbell portfolio.

A

True

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