Fixed Income II Flashcards
Duration - impact of call options
Less sensitive - limits upside price movement
Duration - impact of put options
Less sensitive - limits downside price movement
Duration Formula
Percentage change in price / percent change in yield
T-bills
(1) maturity < 1 year
(2) 4-week, 3-month, and 6-months
Treasury notes
(1) Semi annual payments
(2) 2, 3, 5 and 10 year maturities
(3) Quoted in 32nds, e.g. 100.5 = 100 & 5/32
STRIP prepayment affect
(1) Interest only receives less
(2) Principal only gets same amount faster
Muni tax treatment
Interest exempt from federal tax
same state = state tax exempt
Capital gains not exempt
Double-baralled munis
Backed by taxes and revenue sources
Appropriation-backed (moral bonds)
State acts as back-up, though not legally required to do so
Revenue bonds
Supported by revenues generated by projects. Do not require voter approval. More risky.
Unsecured debt (debentures)
Not backed by any pledged asset
Commercial paper
< 270 days, exempt from SEC regulations
Issued at a discount like t-bills
Bankers acceptance
Letter of credit guaranteeing payment between two banks, usually when shipping goods.
Special purpose vehicle
(1) Separate legal entity
(2) Shields assets from corporations general creditors
(3) Used for ABS
(4) allows for higher rating
Collateralized Debt Obligation (CDO)
Debt instrument with underlying pool of other debt.
Tranches are created based on seniority and claims to cash flow.
Pure expectations theory
(1) Yield curve represents expectations of short term rates in the future
(2) If short-term rates are expected to rise, future rates are higher than current rates
Liquidity preference theory
(1) In addition to pure expectations, investors require a risk premium for holing longer dated bonds
(2) yield curve can still slope down if expectations exceed liquidity premium
Market segmentation theory
(1) supply and demand dictate rates over different time periods
Preferred habits theory
(1) Weaker form of market segmentation theory
(2) Investors can be induced to move from preferred ranges, if rates are high enough.
Yield to maturity
Single discount rate that makes present value of a bod’s future cash flows equal to market price.
Spot rate
Discount rate for individual future payments.
Absolute yield spread
Yield on higher yield bond - yield on lower yield bond
Relative yield spread
Absolute yield spread / benchmark bond yield
Yield ratio
Subject bond yield / benchmark bond yield
After tax yield formula
taxable yield * (1-marginal tax rate)
Taxable equivalent yield
(tax free yield) / (1-marginal tax rate)
