Fixed Income I Flashcards
Types of debt (2)
(1) Preferred stock and (2) debt
Affirmative covenants
What the borrower promises to do:
(1) pay interest and principal
(2) pay taxes when due
(3) maintain property, etc
Negative covenants
Limitations on borrower’s activity (e.g. no new debt)
Maturity (short, medium, long)
Short: 1 - 5 years
Medium: 5 - 12
Long: >12
Step-up notes
Coupon rate increases over time
Deferred coupon bonds
Interest deferred originally, then paid later. Rates are typically higher.
Dirty price
Price + interest
Default (accrued interest)
When in default sold without accrued interest
Bullet
Only interest is paid until maturity, maturity all principal is returned.
Call provision
Gives bond issuer right to retire debt before maturity
Nonrefundable
Can be called by issuer, but not replaced by new debt at a lower yield.
Sinking fund provision
Company retires a certain amount of debt each year.
(1) lowers credit risk, less debt outstanding,
(2) bad if your debt gets called though
Conversion privilege
Allows bond holder to convert to specified number of shares
Put provision
Allows bond holder to put back to issuer at a specified price on designated dates
Embedded options for issuer (4)
(1) right to call
(2) right to prepay principal
(3) Accelerated sinking fund
(4) Cap on a floater
Embedded options for bond holder (3)
(1) conversion privilege
(2) Right to put the issue
(3) cap on a floater
Repurchase agreement
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.
Duration formula
(price if yield declines - price if yield rises) / (2 * initial price * change in yield)
Duration assumption
Parallel shift in yield curve
Reinvestment risk
Yield quoted on bond assumes reinvestment at same rate, may not be possible.
Callable bond price formula
Price of callable bond = price of option free bond - price of embedded cal
Yankee bonds
Issued by non-US companies and traded in the U.S.
Supranatural
Entity formed by two or more central governments through international treaties
Single price bid auction
Securities are awarded at the highest bid that clears the whole inventory.
Multi price bid auction
Individuals receive the price of the bid that they put forth.
TIPS
Coupon and principal adjusted by inflation amount
Government sponsored enterprises
Privately owned and publicly chartered entities created by Congress:
(1) Farmer Mac
(2) Freddie Mac
(3) Sallie Mae
(4) Fannie Mae
MBS
Mortgage Passthrough Securities
(1) Bundle of mortgages
(2) Spreads prepayment risk across number of issues
(3) Pays each member equally
CMOs
Collateralized Mortgage Obligations
(1) Different tranches with different risk/priority
Redeemed
Called through call option or sinking fund
Refunded
Lower yield debt issued to call older debt
Accelerated sinking fund
Required to retire $10m, but retiring more
Benefits of REPOs
(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
