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2020 CFA LEVEL II > Fixed Income > Flashcards

Fixed Income Flashcards

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CFA flashcards
1
Q

riding the yield curve

A

when yld curve is UPWARD sloping, holding long-maturity bonds, earns an excess return as the bond “rolls down the yield curve)

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2
Q

swap rate curve

A

reflect credit risk of commercial banks rather than gov’t
swap market is not regulated by any gov’t
swap curve typically has yield quotes at many maturities

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3
Q

swap spread

A

swap rate - t-bill

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4
Q

z-spread

A

when added to each spot rate on the yld curve, makes the pv of a bond’s cf equal to the bond’s market price

appropriate spread measure for option-free corp. bonds, credit CDS, and ABS.

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5
Q

TED spread

A

3-month libor - 3-month T-bill rate

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6
Q

Libor-OIS spread

A

amount by which the LIBOR rate exceeds the overnight indexed swap rate.
it’s a useful measure of credit risk and provides an indication of the overall well-being of the banking system.

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7
Q

unbiased expectations theory

pure expectation

A

forward rates are an unbiased predictor of future spot rates

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8
Q

local expectations theory

A

preserves the risk-neutrality assumption only for short holding periods, whole over long periods, risk premiums should exist
This implies that over ST period, every bond should earn rf.

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9
Q

liquidity preference theory

A

investors demand a liquidity premium that is positively related to a bond’s maturity

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10
Q

segmented markets theory

A

shape of the yld curve is the result of the interactions of supply and demand for funds in diff. market segments

investors in one maturity segment of the market will not move into any other maturity segments.

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11
Q

preferred habitat theory

A

similar to segmented markets theory, but recognizes that market participants will deviate from their preferred maturity habitat if compensated adequately.

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12
Q

equilibrium term structure models

CIR

A

Assumes the economy has a natural long-run interest rate (b) that short-term rate converges to.
dr=a(b-r)dt+sigma sqr(r)dz

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13
Q

equilibrium term structure models - Vasicek model

A

assumes that interest rate volatility level is independent of the level of ST interest rates
constant volatility
dr = a(θ − r)dt + σdz

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14
Q

arbitrage models -Ho-Lee model

A

is calibrated by using market prices to find the time-dependent drift time that generates the current term structure.
dr(t) = theta dt + σdz

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15
Q

effective duration

A

sesitivity of a bond’s price to parallel shifts in the bmk yld curve

=BV(-change in yld) - BV(+ change in yld)
/ 2BV0*change in yld

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16
Q

key rate duration

A

measures bond price sensitivity to a change in a specific par rate, keeping everything else constant

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17
Q

sensitivity to parallel, steepness, and curvature movemtns

A

measures sensitivity to three distinct categories of changes in the shape of the benchmark yield curve.

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18
Q

binomial interest rate tree framework

A

lognormal random walk model with 2 equally likely outcomes

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19
Q

pathwise valuation

A

value of the bond is the avg of the values of the bond at each path
2^(n-1) possible paths

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20
Q

monte carlo forward-rate simulation

A

uses pathwise valuation and a large number of randomly generated simulated paths

used to value MBS

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21
Q

Value of Call option

A

=Vs-Vcallable

22
Q

Value of Put option

A

=Vputable-Vs

23
Q

OAS

A

the constant spread added to each forward rate in a bmk binomial interest rate tree, such that the sum of the pv of a credit risky bond’s cash flows equals its market price

=z-spread - option cost

24
Q

one-sided duration

A

when interest rates rise versus when they fall
better at capturing interest rate sensitivity than regular effective durations

when option is at-or-near-the-money, callable/putable bonds will have lower/higher one-sided down-duration than one-sided up-duration

25
Q

effective convexity

A

positive for straight and putable bonds
callable bond have negative convexity

BV-+BV+-2BV0
/ (BV*CHANGE IN YLD^2)

26
Q

value of capped floater

A

=value of straight floater - value of embedded cap

27
Q

value of a floored floater

A

=value of straight floater + value of embedded floor

28
Q

conversion value

A

market price of stock * conversion ratio

29
Q

market conversion price

A

market price of convertible bond / conversion ratio

30
Q

market conversion premium/share

A

market conversion price - market price

31
Q

minimum value of convertible bond

A

max(straight, conversion value)

32
Q

callable and putable convertible bond value

A

= straight value of bond
+ value of call option on stock
- value of call option on bond
+ value of put option on bond

33
Q

recovery rate

A

% recovered in the event of default

34
Q

LGD=

A

loss severity (1-recovery rate) * exposure

35
Q

POD

A

likelihood of default

36
Q

CVA

A

sum of pv of expected loss

37
Q

% change in Price

A

-(md)*change in spread

38
Q

structural models of corp. credit risk

A

are based on structure of bs and rely on insights provided by option pricing option theory
assumes that rf is not stochastic

Structural models do not account for the impact of interest rate risk of the value of a company’s assets.

value of stock = max (At-K,0)
Value of debt = min(K,At)

39
Q

value of risky debt

A

value of rf debt - value of a put option on assets
CVA= value of put option
short a put option on company’s assets for debt investors

40
Q

reduced form models

A

do no explain why default occurs
explain when default occurs

default under RF is randomly occurring exogenous variable - the default intensity (pod over the next period)
allow for company fundamentals change as well as when the state of economy changes

41
Q

credit spread on a risky bond

A

YTM of a risky bond - YTM of bmk

42
Q

CDS

A

CDS buyer get paid when default occur, pays the premium - CDS spread
buyer shorts credit risk

43
Q

expected loss

A

harzard rate * LDG

44
Q

upfront payment by protection buyer

A

PV(protection leg) - pv(Premium leg)

=(CDS spread - CDS coupon)* CDS duration

45
Q

profit for protection buyers (%)

A

change in spread (%) - CDS duration

is said to be short the reference entity’s credit risk and is bearish on the financial condition of the reference entity

46
Q

naked trade

A

investor with no exposure to the underlying purchases protection in the CDS market

47
Q

curve trade

A

long/short trade where the investor is buying and selling protection on the same reference entity but with diff. maturities

short-term better, buy long-term CDS and selling ST CDS

48
Q

Changes in the shape of yield curve is explained by (in order of importance):

A

level, steepness and curvature.

49
Q

under structure model, owning risky debt is equivalent to a long position in a similar rf bond and

A

a short position in a pot option on assets of the companys

50
Q

valuation of bond based on OAS

A

OAS <0 or < required OAS, overvalued

OAS> required OAS, undervalued

51
Q

tranched CDS

A

covers a combination of borrowers but only up to a pre-specified levels of losses, much in the same manner that abs are divided into tranches.

2020 CFA LEVEL II (15 decks)

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