Fixed Income I

Question 1

Types of debt (2)

Answer 1

(1) Preferred stock and (2) debt

Question 2

Affirmative covenants

Answer 2

What the borrower promises to do:

(1) pay interest and principal
(2) pay taxes when due
(3) maintain property, etc

Question 3

Negative covenants

Answer 3

Limitations on borrower’s activity (e.g. no new debt)

Question 4

Maturity (short, medium, long)

Answer 4

Short: 1 - 5 years
Medium: 5 - 12
Long: >12

Question 5

Step-up notes

Answer 5

Coupon rate increases over time

Question 6

Deferred coupon bonds

Answer 6

Interest deferred originally, then paid later. Rates are typically higher.

Question 7

Dirty price

Answer 7

Price + interest

Question 8

Default (accrued interest)

Answer 8

When in default sold without accrued interest

Question 9

Bullet

Answer 9

Only interest is paid until maturity, maturity all principal is returned.

Question 10

Call provision

Answer 10

Gives bond issuer right to retire debt before maturity

Question 11

Nonrefundable

Answer 11

Can be called by issuer, but not replaced by new debt at a lower yield.

Question 12

Sinking fund provision

Answer 12

Company retires a certain amount of debt each year.

(1) lowers credit risk, less debt outstanding,
(2) bad if your debt gets called though

Question 13

Conversion privilege

Answer 13

Allows bond holder to convert to specified number of shares

Question 14

Put provision

Answer 14

Allows bond holder to put back to issuer at a specified price on designated dates

Question 15

Embedded options for issuer (4)

Answer 15

(1) right to call
(2) right to prepay principal
(3) Accelerated sinking fund
(4) Cap on a floater

Question 16

Embedded options for bond holder (3)

Answer 16

(1) conversion privilege
(2) Right to put the issue
(3) cap on a floater

Question 17

Repurchase agreement

Answer 17

Sell bond with agreement to later repurchase same securities back at a specified date and price. Repo rate based on difference between sell and buy price.

Question 18

Duration formula

Answer 18

(price if yield declines - price if yield rises) / (2 * initial price * change in yield)

Question 19

Duration assumption

Answer 19

Parallel shift in yield curve

Question 20

Reinvestment risk

Answer 20

Yield quoted on bond assumes reinvestment at same rate, may not be possible.

Question 21

Callable bond price formula

Answer 21

Price of callable bond = price of option free bond - price of embedded cal

Question 22

Yankee bonds

Answer 22

Issued by non-US companies and traded in the U.S.

Question 23

Supranatural

Answer 23

Entity formed by two or more central governments through international treaties

Question 24

Single price bid auction

Answer 24

Securities are awarded at the highest bid that clears the whole inventory.

Question 25

Multi price bid auction

Answer 25

Individuals receive the price of the bid that they put forth.

Question 26

TIPS

Answer 26

Coupon and principal adjusted by inflation amount

Question 27

Government sponsored enterprises

Answer 27

Privately owned and publicly chartered entities created by Congress:

(1) Farmer Mac
(2) Freddie Mac
(3) Sallie Mae
(4) Fannie Mae

Question 28

MBS

Answer 28

Mortgage Passthrough Securities

(1) Bundle of mortgages
(2) Spreads prepayment risk across number of issues
(3) Pays each member equally

Question 29

CMOs

Answer 29

Collateralized Mortgage Obligations

(1) Different tranches with different risk/priority

Question 30

Redeemed

Answer 30

Called through call option or sinking fund

Question 31

Refunded

Answer 31

Lower yield debt issued to call older debt

Question 32

Accelerated sinking fund

Answer 32

Required to retire $10m, but retiring more

Question 33

Benefits of REPOs

Answer 33

(1) repo rate is usually less than margin (asset-backed)
(2) Not regulated by the Federal Reserve, like margin
(3) Better terms for the lender - technically own security so easier if bankruptcy