Fixed Income III

Question 1

Steps in bond valuation (3)

Answer 1

(1) estimate coupon and principal payments
(2) Determine discount rate
(3) Calculate present value baed on individual flows

Question 2

Zero coupon bond payment notes

Answer 2

N = # of years * 2 (semi annual payments)

I/Y = YTM / 2 (semi annual payments)

Question 3

Arbitrage free valuation

Answer 3

Discount bond based on rate for each cash flow

Value must be worth sum of parts, or else arbitrageur could earn a risk free return

Question 4

Current yield formula

Answer 4

annual cash coupon / bond price

Question 5

Yield to maturity

Answer 5

Includes interest and capital gains/losses if purchased at discount/premium

Question 6

Yield to maturity formula

Answer 6

Use TMV of money keys to solve for “I”

Solve for semi annual I and * 2 to get annual

Question 7

Bond equivalent yield (BEY)

Answer 7

Semi annual rate * 2

Same as YTM for semi-annual bond

Question 8

Yield-to-call

Answer 8

Same as YTM, but:

(1) Time until call date is substituted for N
(2) Call price is substituted for FV

Question 9

Yield-to-worst

Answer 9

This is the worst yield given call provisions. Calculate YTM, YTC, etc and pick the worst.

Question 10

Yield-to-put

Answer 10

Same as YTC, but

(1) N = periods to put provision
(2) FV = put price

Question 11

Yield drawback

Answer 11

Most IRR yields (YTM for example) assume reinvestment at same rate

Question 12

Z-spread

Answer 12

Rate that would need to be added to each point on the spot curve for the geometrically linked rate to equal that of the risky bond

Question 13

Z-spread vs. nominal spread

Answer 13

Z-spread > nominal spread if yield curve is positive
Z-spread < nominal spread if yield curve is negative
Z-spread = nominal spread if yield curve is flat

Question 14

Z-spread and OAS

Answer 14

Z-spread - OAS = option cost in percent

Question 15

OAS

Answer 15

Z-spread but also including impact of options

Question 16

Forward rate agreement (FRA) notation: 1f3

Answer 16

1-year rate, beginning in year 3

Question 17

Forward rate agreement (FRA) definition

Answer 17

(1) Agreement to borrow/lend money at a certain rate in the future
(2) No actual loan made, settled in cash
(3) Long has right to borrow and makes money if rates increase

Question 18

Forward rate agreement (FRA) notional payout

Answer 18

(market rate - contract rate) * (days/360) * notional value of loan

Question 19

Forward rate agreement (FRA) interest payout

Answer 19

Notional payout / (1+interest rate) * (days/360)

Where interest = current market rate

Question 20

Forward rate agreement (FRA) 2-by-5

Answer 20

2-by-5 = in 60-days based on 90-day LIBOR

Question 21

Forwards and swaps

Answer 21

Custom and OTC

Question 22

Future

Answer 22

(1) Forward contract that is standardized and cleared
(2) Daily settlement of P/L
(3) At initiation priced at zero

Question 23

Swap

Answer 23

Series of forward contracts

Question 24

Forward

Answer 24

Agreement to buy/sell physical asset or security at a specific price on a specific date

Question 25

Long forward

Answer 25

Person that agrees to purchase the security (short will sell)

Question 26

Forward offsetting contracts

Answer 26

Can enter with another person, but still have counter party risk

Question 27

Eurodollar deposits

Answer 27

Deposits in large banks outside of the US in US dollars

Question 28

LIBOR

Answer 28

Quoted in annualized rate

Question 29

Currency forward payout

Answer 29

(Actual rate - specified rate) * notional = gain/loss

Question 30

OAS

Answer 30

Removes affect of options. I.e. OAS - option effect = z-spread