Fixed Interest Flashcards
What happens to the price and yield of a bond if interest rates in the market increase?
Price of bonds fall
Yields will rise
If interest rates in the market fall what happens to bond prices and yields?
Price will rise
Yield will fall
In what circumstances is the fixed interest paid by bonds more attractive?
When interest rates in the market fall
What is a yield curve?
Shows the relationship between yields on bonds and the time they have remaining to redemption.
On a graph short dated bonds will be on left and long dated on right
Indication of market expectations
Why are long dated bonds considered higher risk?
Far more uncertainty regarding long term interest rates and inflation.
Investors demand higher returns on long dated bonds as a reward for risk taken.
Will pay less so yields will be higher
What is a normal (positive) yield curve show?
Shows the yield increasing the longer the term to redemption
Long dated bond yield more than short dated ones
Reflects investors expectations regarding long term interest rates and inflation will be higher
What are investors expectations when there is a normal yield curve?
Investors may be willing to accept low yields in short term if interest rates are low
If interest rates are expected to rise then they will demand higher rates over long term
What causes a shallow or flat yield curve?
When interest rates are expected to remain same level over long term.
Means little difference between short and long dated bond yields
What causes an inverted yield curve?
Interest rates are currently very high but expected to fall significantly in the future
Investors may demand high yields on short dated but prepared to accept lower yields on long dated stock.
Short term inflation will rise and long term inflation fall
If long dated gilts are in short supply (high demand by pension providers) pushes up prices and reduces yields
What is the least volatile bonds?
Short dated
High coupon
What is the most volatile bond?
Long dated
Low coupon
Undated most volatile
What does pull to redemption mean?
As bonds come closer to redemption their prices become close to par
No one would wish to sell for significantly less than £100 or buy for significantly more than £100 if close to redemption.
What are long dated bond prices more affected by?
Interest rate changes
What is the tax position on gilts?
No CGT on disposal
Coupons pay gross but income tax due by self assessment
What is modified duration?
Measure of sensitivity of bonds price
To changes in interest rates
