Fixed Income Flashcards
What is tenor?
Time period until maturity
What is perpetual bond?
Bond with no maturity
What is floating-rate notes (FRNs)?
Its coupon is based on the variable market rate of interest
What is market reference rate (MRR)?
It is variable market rate of interest
What are contingent provisions?
Fixed income securities that may have embedded options
What is yield of a bond?
It is expected return of a bond
What is relationship between bond yield and price?
Inverse
How does bond yield curve looks?
It is upward sloping, the higher the maturity, the higher the yield
What is used as benchmark for credit spreads?
Government bonds
How sovereign bonds are repaid?
From current/future taxes
What is secured bond?
It is repaid from operating cashflows with collateral if it defaults
What is unsecured bond?
It is repaid from operating cash flows only
What is affirmative covenant?
It is specific requirement the issuer must fulfill
What is cross default covenent?
If issuer defaults on any other debt, then it is considered to default on this one as well
What is pari passu?
Bond will have the same priority as any other senior debt
What are negative covenants?
They are restrictions put on the issuer
What is negative pledge cause?
Issuer cannot issue more senior debt than existing one
What is amortizing loan?
Periodic payments include interest and some repayment of principle
What is fully amortized?
Payment is fully paid off with the last payment
What is partially amortized/ballon payment bond?
Some remaining part of principle is repaid at the maturity
What is sinking fund provisions?
It is repayment of principle thorugh series of payment over the lifetime e.g. some random payment of X at year Y
What is waterfall structure?
It is used to establish principle payments for AB and MBs, where junior tranches does not receive principle repayments until senior tranches are paid
What is step-up bond?
Coupon rate increases overtime based on the schedule
What is credit-linked bond?
Its coupon increases if credit rating detoriates
What is payment in kind bond?
It allows issuers to make the coupon payments by increasing principle amount of the other outstanding bonds
What are green bonds?
Its payments increases if certain environmental goals are not met by the issuer
What are index-linked bonds?
Its principle or coupon is based on the published index
What are inflation linked bonds?
Its coupon rate is adjusted, but principle remains
What is capital-index bonds?
Coupon rate remains, but principle amount is adjusted
What are deffered coupon bonds?
Regular coupon payments do not begin until specified time after issuance
What is contingence provision?
It is specified action that needs to be taken in event actually occurs
What is call protection?
It is time period for which bond in not callable
What is call risk?
It is uncertainty about the redemption date
What is contingent convertible bond?
Its bonds that convert from debt to common equity automatically if specific event occurs
What is domestic bond?
Bond issued in the same market in which bonds are issued and traded
What is foreign bond?
Its bonds on issuers from countries other than the market in which bond trades
What are Eurobonds?
Bonds issued outside the jurisdiction of any one country and can be issued in any currency
What are global bonds?
Bonds that trade in at least on of the domestic market as well as in the Eurobonds market
What are international bonds?
Bonds that involve more than one market
What is income paid to bondholders treated?
As ordinary income
What are Sukuk bonds?
Sharia-compliant bonds with specific restrictions on the payment of interest and use of proceeds to comply with islamic law
If you sell coupon before maturity, how it is treated?
It is considered as capital loss/gain and is taxed at lower rate than the ordinary income
What are main differences between bond and equity indexes?
Many different bonds are used, they have frequent turnover, sovereign bonds makes significant part
What is debut issuer?
It is issuer that is offering first ever bond
What is underwritting offering?
It is price of the bond guaranteed by the financial intermediary
What is best-efforts offering?
It is when price is not guaranteed, but the intermediary tries its best to sell at best conditions
What is shelf registration?
It is when bond issue is registered with regulators in tis aggregates value with master prospectus
What is distressed debt?
It is bonds of issuers that are expected to file for bankcrupty
What are on the run bonds?
The most recent issue of the bonds
What are seasoned bonds?
Older bonds of the issuer/on the market
What is commercial paper?
It is ST unsecured debt security issued by large corporations with high credit ratings
What is bridge financing?
It is temporary debt until permanent financing can be secured
What is rollover risk?
It is risk that re-issued CP will not be sold
What are checking accounts?
It offers transaction services and immediate avaiability of funds, but pays no interest
What are operational deposits?
it is depostis made by larger customers who require cash management, custody and clearing services
What are saving deposits?
They have stated term and interest rate
What is certificate of deposit?
It pays interest at specified maturity <1y, might be nonnegotiable meaning that it cannot be sold before maturity and ealy withdrawals may face a penalty
What are interbank funds?
It is when banks lend to each other for periods of one day to one year.
What is repurchase agreement (repo)?
It is arrangement by which one party sells a security to a coutnerparty with a commitment to buy it back at the later date and higher price
Formula of repo purchase price
market value of security/initial margin
Formula of repo repurchase price
purchase price*(1+repo rate)
What is haircut?
It is discount applied to market value of collateral to get purchase price
Formula of haircut
(market value-purchase price)/market value
or
1-1/initial margin
What is variation margin?
It is when more collateral is asked if market value of collateral fall below this value and initial margin
Formula of variation margin
(initial margin*adjusted purchase price)-market value of collateral
What are overnight and term repos?
Overnight - one night, term - longer
What is master repurchase agreement?
It is details of the contractual terms of the repo
When repo rate is higher? (3)
IR for alternative ST funding is higher, longer repo term, repo is undercollateralized
When repo rate is lower? (2)
It has higher credit quality of collateral, collateral is in high demand or low supply
What is bilateral repo?
Agreement between two parties
What is tri-party repo?
It employs third party intermediary as an agent
In what currency debt is denominated in developed markets?
Reserve currency
In what currency debt is denominated in emerging markets?
Domestic or external
What is domestic debt?
Debt denominated in the issued entities home country currency and is held by the domestic investors
What is external debt?
It may be denominated in home currency or gireghn reserve currency
What are general obligation bonds?
It is debt raised for general public spending backed by local tax raising power
What are revenue bonds?
It is bonds issued for a specific project where funds for repayment comes from fees
What are supranational bonds?
These are bonds issued by international institutions
Where sovereign bonds are traded when first issued?
In the public autions
What are competitive bids?
These are used to set the price of the debt issue
What are noncompetitive bids?
They have guaranteed allocation based on the price determined by the competitive bids
What is cut-off bid?
It is last succesful bid with lowest price
What is YTM?
It is discount rate used for bonds
Formula of accrued interest
Coupon payment*(days from last coupon to settlement/days in the coupon period)
What is full price of the bonds?
It is sum of flat price and accrued interest
Formula of full price
PV on last coupon date*(1+(YTM/periods per n)^days since last coupon/days in coupon period
What bonds are more sensitive to a change in yield?
Lower coupon rate and higher maturity
What is matrix pricing?
It is method of estimating YTM of bonds that are not currently traded or infrequently traded
Formula of an annual yield
(1+YTM/n)^n-1
What is street convention?
It is when coupon dates fall on weekends or holidays so coupon payments will actually be made the next business day
How true yield is calculated?
Using real coupon payment dates
What is current yield?
It looks at only annual interest income
Formula of current yield
annual cash coupon payment/bond price
What is simple yield?
It takes discount or premium into account by assuming that any discount or premium declines evenly over the remaining years
What is yield to worst?
It is lowest YTM of various yields
Formula of callable bond value
staight value of bond-call option value
What is option adjusted yield?
It is yield that bond would be offering if it didnt have the embedded option
What is yield spread?
It is difference between the yield of a bond with its benchmark
What is G-spread?
It is yield spread on government bond
What is interplatted/I spread?
It is yield spread relative to swap rates that represent extra return of a bond in excess of the interbank MRR used in swap contracts
What are spot rates?
These are yields earned by individual cash flows at different maturities
What is option adjusted spread?
It is when option effect is taken out
What is formula for option value?
Z-spread-OAS
What is Z-spread?
It is amount which added to the spot rates will produce value equal to the bond price
How values of FRN and fixed-rate debt compare?
Values of FRN are more stable as coupon is reset periodically
Formula of coupon rate FRN
risk-free rate MRR+fixed margin (also called quoted margin)
What are add-on yield?
Yield when investor plans to reinvest coupon payments at different rates from YTM
What is discount yields?
It is annualied current discounts from the face value of money market securities received at maturity
Formula of quoted add-on yield
HPY*365/days to maturity
Formula of quoted discount yield
actual discount*360/days to maturity
What is bond equivalent yield?
It is add-on yield quoted on a 365-days basis
What are par yields?
It is coupon rate that bond at each maturity would need to have to be priced at par
What is forward rate?
It is borrowing/lending rate for a loan to be made in the future
Formula structure for forward rate structure
(1+S)^3=(1+S)^2*(1+2y1y)
What are sources of capital from fixed rate bond? (3)
Coupon and principle payments, interest earned on coupon payments that are reinvested over the investors holding period, capital gain or losses
What is horizon yield?
It is compound annual return earned from bond over the horizon period
Formula of rate of return of a bond
(principle+FV of coupon payment)/(price of the bonds)^1/n-1
What is carrying value of a bond?
It is value of a bond at certain time after purchase, assuming the original yield of the bond has not changed
What are parameters of short investment horizon?
price risk>reinvestment risk, increase in yield, decrease in rate of return
What are paramenters of long investment horizon?
reinvestment risk>price risk, increase in yield, increase in rate of return
What is Macaulay duration?
It is average time until the receipt of the each cash flows of the bond
What is duration gap?
It is difference between bond’s Macaulay duration and your investment horizon
What is Modified duration?
It is sensitivity of price given change in YTM
Formula of Modified duration
MacDur/(1+YTM)
Formula of change in price with ModDur
-ModDur*change in YTM
Formula of approximate ModDur
V(-)-V(+)/2V0change in YTM
What is Money duration?
It is ModDur in money terms
Formula of money duration
annual ModDur*full price of bond position
What is price value of a basis point?
It is money change in the full price of a bond when its YTM changes by one basis point or 0.01%
Formula of PVBP
V(-)-V(+)/2
What is relationship with maturity and MacDur?
Direct relationship
What happens to Macaulay Duration when YTM remains constant between coupon dates?
It decreases smoothly and then slightly goes back up at each coupon payment date
What is relationship between coupon rate and interest rate risk?
Inverse
Which will have higher duration - zero or coupon bond?
Zero bond
What is relationship between YTM and interest rate risk?
Inverse
Formula of convexity of cash flow at period t
t(t+1)/(1+r)^2
How to annualize convexity of CF?
Divide by the number of period per year squared
Formula of approximate convexity
(V(-)+V(+)-2V0)/(changeYTM^2*V0)
What fctors of maturity, coupon rate and YTM increases convexity?
Longer maturity, lower coupon rate, lower YTM
Formula of change in bond’s price with ModDur and convexity
-annual ModDur(change in YTM)+0.5annual convexity*(change in YTM)^2
Formula of money convexity
annual convexity*full price of bond position
Formula of portfolio duration
weighted average of each security
What is limitation of portfolio duration approach?
It assumes that YTM of everybond in the portfolio changes by the same amount
What is effective duration?
It is duration of a bond with embedded options, shows price change given change in the IR
Formula of effective duration
V(-)-(V+)/(2V0change in curve)
Formula of effective convexity
((V-)+V(+)-2V0)/(change in curve)^2*V0
What is convexity of a callable bond?
It can show negative convexity at low yields
How duration of aembedded bond compares to option-free bond?
It is always less
What is convexity of a putable bond?
Always positive
Formula of effective price change
-EffDurchange in curve+1/2EffCon*(change curve)^2
What is key rate duration?
It is sensitivity of the value of the bond ot portfolio to changes in the benchmark yield for specific maturity, holding other yields constant
What is shaping risk?
It is effect of a non parallel shift in the yield curve on bond portfolio
What are empirical durations?
It is use of actual observed historical relationship between benchmark yield changes and bond price changes
What is credit risk of a bond?
It is risk associated with losses to fixed income investors streaming from failure to make payments
What are components of bottom-up analysis of credit risk? (5)
Capacity, capital, collateral, covenants and character
What are components of top down analysis of credit risk? (3)
Conditions, country, currency
What does it mean of being illiquid?
Inability to raise cash to service debt
What does it mean to be insolvent?
It is when assets of an issuer fall below value of its debt
Formula of expected loss
probability of default*loss given default
What is recovery rate?
It is proportion of claim investor will recover if issuer defaults
Formula of loss severity
1-recovery rate
What is expected exposure?
It is difference between amount investor is owed and value of collateral
Formula of loss given default in %
expected exposure*(1-recovery rate)
Formula of LDG credit spread
probability of default*LDG%
What are risks of relying on credit agencies? (3)
Credit rating lag market pricing, some risks are difficult to assess, mistakes of credit agencies
What is credit spread risk?
It is risk that yield spread widen due to detoriating conditions, causing credit-risky bonds prices to decrease
What are incentives of exposure to high credit risk? (3)
Diversification, capital appreciation, equity-like returns
What is market liquidity risk?
Transaction costs of trading a bond
How market liquidity risk is examined?
Based on bid-offer spread
How to calculate credit risk?
Difference of yields usng bid-offer sprad is liquidity risk and remaining part ir credit risk
What is corporate family ratings (CFR)?
It is rating based on senior unsecured debt
What is corporate credit rating (CCRs)?
It is rating of a specific issue
What is notching?
Assigment of individual issue rating that differ from the issuer rating
What is process of securization?
Pool of debt-based assets is created, this pool is sold to SPE, SPE issues fixed-income securities supported by the cash flows from the collateral
What does it mean to be bankcruptcy remote?
Buyers of ABS are not affected by the financial position of the seller/servicer and does not have claims on other assets
What is purchase agreement?
Terms of the purchase of the collateral by SPE
What are covered bonds?
They are senior debt obligations of financial institutions that are similar to ABS, but underlying assets are not removed from the balance sheet as no SPV is created
What is hard-bullet covered bond?
If issuer fails to make payments on time, amount due is accelerated to covered bondholders
What is soft-bullet covered bonds?
Failed payments can postpone maturity up to 1 year
What are conditional pass-through covered bonds?
It convers to pass-through bond on the maturity date if any payments remains due, meaning that any payments recovered are passed to investors
What is overcollateralization?
It is when value of collateral exceeds face value of the ABS
What is excess spread feature?
Reserve building in the ABS structure by earning higher income on the collateral than the coupon promised to ABS investors
What is credit tranching?
It is ABS structure with multiple classes of securities, each with different claim to CF of the collateral
What is equity tranche?
The most junior one that gets pay last
What is lockout period?
It is period when only fees and interest payments are made
What are types of collateralied loan obligations? (3)
Cash flow, market value and synthetic
What are cash flow CLO?
cash flows to investors are generated through cash flows on the underlying collateral
What is market value CLOs?
cash flows are generated through trading market value of underlyign collateral
What is synthetic CLOs?
Collateral pool exposure is generated through credit derivative contracts
What is prepayment risk?
It is risk that principle payments by mortgage borrowers in excess of the schedule principle repayments for amortizing loans
Why prepayments are bad for MBS?
They are repaid in low-interest environment and face lower reinvestment return, prices will not rise as much as other fixed income instruments
What is residential mortgage loan?
It is loan where underlying asset is residential real estate
What are agency RMBS?
They are guaranteed by the governments or government sponsored enterprise
What are non-agency RMBS?
They are issued by private entities and have no government or GSE guarantee
What are mortgage pass through security?
It is claim on the cash flows from a pool of mortgages, net of administration fees
What is Z-tranche?
It is tranche which receives no interest payment during a specified accrual period, but interest is added to principle
What are planned amortization class tranches?
It is predictable payments as long prepayment speeds remain within a certain range
What is defeasense?
It is when borrower uses payments in excess of scheduled loan payments to purchase a portfolio of government securities that is sufficient to make the remaining scheduled principle and interest payments of the loan
