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QFI-QF > Fixed Income Securities, FIS > Flashcards

Fixed Income Securities, FIS Flashcards

1
Q

Describe four common types of government debt

A
  1. Treasury Bills - short term debt, maturity up to 1 year
  2. Treasury Notes - medium term debt, maturity up to 10 years (semi annual coupons)
  3. Treasury Bonds - long term debt, maturity up to 30 years
  4. TIPS - bonds whose principal is indexed to inflation
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2
Q

Define a repurchase agreement

A

A contract where you sell a security to a pary with an agreement to buy it back at a future date

  1. Equivalent to a collaterized loan
  2. Repo rate - interest behind the loan
  3. Reverse repo - opposite of repo
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3
Q

State the formula for the repo interest

A

(n / 360) * Repo Rate * (P_t - Haircut)

- haircut is deducted from the bond market price when selling the instrument

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4
Q

State the formula for the return on capital of a repo trade

A

(P_T - (P_t - Haircut) - Repo Interest) / (Haircut)

  • bond sells for P_T
  • pay borrowed money with interest
  • initial investment is the haircut
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5
Q

Define the discount factor

A

The time value of $1 between times t and T

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6
Q

Compare bootstrapping with the Nelson-Siegel model

A

Bootstrapping:
- yield curve can have dips at certain tenors due to liquidity issues, staleness, or bad data
- difficult to correct bootstrapping issues
Nelson-Siegel:
- correct discontinuities using a parametric form

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7
Q

State the formula for pricing a semi-annual floating rate bond with a spread s

A

Price = Z(t, T_i+1)N(1 + r_2(T_i)/2)

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8
Q

State the price formula for an (leveraged) inverse floater

A

Price = NPrice(ZCB) + Price(ZCB at fixed rate) - NPrice(floating rate bond)
- Coupon = Fixed Rate - N*Floating Rate

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9
Q

State problems and potential solutions for bootstrapping

A

Number of Bonds > Number of Maturities
- use linear regression (C^TC)C^T*P(0)
Number of Bonds < Number of Maturities
- use Nelson-Siegel or splines

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10
Q

State one issue that is hard to correct with bootstrapping

A

The yield curve can have a dip at certain tenors
- liquidity issue
- staleness
- bad data
Key Point: hard to correct for these issues with bootstrapping

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11
Q

Define duration

A

Sensitivity of the price to a small parallel shift in the IR curve: (-1/P)(dP/dr)

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12
Q

Explain how the duration depends on the coupon rate and the interest rate

A

Higher coupon rate = lower duration
- higher coupon rate = cash flows larger in the near future
- cash flows arriving sooner are less sensitive to the IR
Higher interest rate = lower duration
- higher IR implies ST cash flows have a higher weight in the value of the bond

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13
Q

Define dollar duration

A

DD = -dP/dr = P*dP

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14
Q

Define VaR

A

The maximum loss that the portfolio can suffer over a time horizon T with an a% probability

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15
Q

Describe two methods of interest rate risk management

A

Cash flow matching - attempt to replicate cash flows exactly
Immunization - replicate present value and duration of the liabilities
- allows for selection of bonds with favorable liquidity and transaction costs

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16
Q

Define convexity

A

Percentage change in the price of the security due to the curvature of the price w.r.t the IR: (1/P)(d^2P/dr^2)

17
Q

Use duration and convexity to approximate change in portfolio value from interest rates

A

dP = -DdrP + 1/2Cdr^2*P

18
Q

State the number of zero coupon bonds to purchase for duration-convexity hedging

A 
K_1 = (-P/P_1)(D*C_2 - C*D_2 / D_1*C_2 - C_1*D_2)
K_2 = (-P/P_2)(D*C_1 - C*D_1 / D_2*C_1 - C_2*D_1)
19
Q

Describe factor models

A

Factor model assumes the IR is driven by a set of factors (slope, level, curvature, etc)

20
Q

State relationships between the spot rate curve and the forward rate curve

A

Spot curve increasing, forward curve above spot curve
Spot curve decreasing, forward curve below spot curve
Spot curve flat, forward curve = spot curve

21
Q

Describe a Forward Rate Agreement

A

One counterparty pays the forward rate, while the other counterparty pays the future floating rate
- Payment at Maturity: NDelta[f(0, T_1, T_2) - r(T_1, T_2)]

22
Q

State the formula for calculating the value of an FRA

A

NZ(t, T_2)Delta*[f(0, T_1, T_2) - f(t, T_1, T_2)]

23
Q

Define a forward contract

A

One counter party agrees to purchase and the other counterparty agrees to sell a given security in the future at the forward price

24
Q

Compare the curve bootstrapped from swaps (LIBOR) vs Treasury Bonds

A

LIBOR curve is slightly higher than the Treasury curve

- spread is a result of credit risk and lower liquidity

25
Q

State advantages of hedging with futures

A

Higher liquidity
Lower credit risk
- clearinghouse guarantees futures contract payments
- use of margin accounts

26
Q

State disadvantages of hedging with futures

A

Higher basis risk
- characteristics of the underlying instrument do not match the characteristics of the instrument to be hedged
Tailing of the hedge
- need to account for time value of money from the cash flows

27
Q

Describe a swaption

A

Payer - call on the swap rate, right to enter a swap to pay the strike rate K
Receiver - put on the swap rate, right to enter a swap to receive the strike rate K

28
Q

What are three sources of interest rate data for bootstrapping a LIBOR curve

A

LIBOR - less than 3 months
Eurodollar - up to 3 years
Swaps - over 3 years

29
Q

Compare options with forwards/futures

A

Options have no downside but have an initial upfront cost

- other contracts can also result in cash outflows for the firm

30
Q

Describe different types of option strategies that can be used as hedges

A

Deductibles - purchasing OTM options to only hedge against an extreme adverse event
Collars - buy call option and sell put option to earn premium to offset the cost of the call
Yield enhancing strategies - make the coupon of a bond sold at par higher by augmenting the bond with a short option position

QFI-QF (10 decks)

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