Fixed Interest Investments Flashcards
1
Q
What is a fixed interest Investment?
A
- Issued by govts., companies and official bodies
- fixed rate of interest (coupon)
- fixed redemption value (par value)
- fixed period, at the redemption date.
- Cannot be cashed before
- Can be traded on stock market
- Interest usually paid 6 monthly
2
Q
What 3 things are included in bond titles?
A
- Issuers Name
- Coupon
- Maturity Date
3
Q
How are bonds priced?
A
- They have a par value of £100
- They are traded above or below this at their nominal price
4
Q
How are bonds traded?
A
- Quoted in the Financial Times but not at exact price as:
- Mid-market prices: between buying and sales point
- Clean prices: ignore the value of accrued interest
5
Q
What is accrued interest on a bond? 2 Methods
A
- Cum dividend: - Purchaser buys full 6 months interest
- Pays clean price plus interest accrued to
that point. - Ex dividend: - If bought within 7 days of interest payment
- Purchaser pays clean price less interest
from date of purchase to interest payment
6
Q
Name the 3 bond markets
A
- Primary Market
- Secondary Market
- Bond Indices
7
Q
What is the Primary Bond Market
A
- When bonds are bough for the first time
- Gilts: - DMO issue weekly auctions
- Large buyers bid at the price they want
- Individuals can bid up to £500,000 + if successful
pay average price - Companies: - Appoint inv. bank to manage the issue +
market the issue
- Buyers place indicative bids to buy at certain
price
- Final terms agreed and issued, then have 24
hours to make firm bids
8
Q
What is the secondary bond market
A
- Subsequent trading of bonds after primary market
9
Q
How are returns for bond expressed? and the 2 types?
A
- As yields
- Interest yield
- Redemption yield
10
Q
Explain Interest Yield
A
- the annual income from the bond as % of price investors would have to pay.
- uses the clean price
- coupon/clean price x 100
11
Q
Why can Interest Yield be confusing
A
- As bond my produce capital gain/loss and that is not factored in
12
Q
Explain Redemption Yield
A
- Takes into account both income and capital.
- adjusts value of each payment for when it is received.
- interest yield + [(gain or loss to maturity/no. years to maturity)/clean price] x 100
13
Q
Explain the relationship/differences between interest yield and redemption yield
A
- if Redemption yield < interest yield there is a capital loss on redemption.
14
Q
Explain downsides to redemption yield
A
- does not account for tax
- one bond may trade near par but have lots of interest (taxable)
- Another may have large capital gain (tax free on gilts + most corp. bonds) and low interest
15
Q
Explain index-linked bonds
A
- Face value increases with index/inflation rate.
- Need an assumption of interest rate when calc value.
16
Q
Risks with bonds (5)
A
- Interest rate risk - when rising bond prices fall
- Liquidity risk
- Inflation risk
- Currency Risk
- Default Risk
17
Q
What factors affect bond prices?
A
- when interest rates rise bond values fall
- when interest rates fall bond prices increase
- specific or commercial risks
- market or systematic risks
18
Q
Explain specific or commercial risks and
A
- the situation of the issuer of the bond
e.g
- creditworthiness of govt/company
19
Q
Explain credit ratings
A
- Investment grade = BBB-/Baa3 to AAA
- Non- investment grade = below BBB-/Bbb3
20
Q
Explain Market or Systematic Risks
A
- Economic changes
- Government Actions - eg. interest rate changes
21
Q
Explain volatility of a bond
A
- Lower the coupon, more volatile
- longer to redemption, more volatile
22
Q
What are bond yields useful for
A
- comparing bonds of different maturities
- indication of the markets expectation of interest rates
- and the required future yields
23
Q
What does the Normal Yield Curve show
A
- Investors demand higher yields for holding bond longer-term
24
Q
What is a yield curve?
A
- shows yield on y axis vs. period to redemption on x axis
25
Q
What does a flat yield curve show?
A
- When economic factors are stable
- Investors accept lower yield and pay more for longer-dated bonds.
26
Q
What does an inverted yield curve show?
A
- yield on long term bonds lower than short term
- expectation that interest rates will fall in short term and be much lower in long term.
27
Q
Categories of Gilts
A
- Shorts - <7 years (DMO) <5 years (financial press)
- Mediums - 7-15 years (DMO) 5-15 (FP)
- Longs - >15 years (DMO + FP)
28
Q
What is an Index linked gilt
A
- coupon and capital move inline with RPI 3 months before payment
- No CGT on disposal
29
Q
Explain Repo Market
A
- one party agrees to sell gilts to another
- Agreement to repurchase at agreed price in the future
30
Q
Name the 2 types of Corporate Bonds
A
- Secured - charge vs. company assets
- Unsecured
31
Q
Explain what a Debenture is
A
- A secured loan between lender and borrower with business assets as security.
- Agreement includes:
- Interest Rate
- Assets backing debenture (fixed or floating charge)
- conditions on borrower eg. restricting amount of money company can borrow
32
Q
Explain Fixed and Floating Charges
A
- Fixed charge - loan secured against assets that can be readily identified + cant be sold
- Floating charge - loan vs. any company assets, can be sold and changed
33
Q
Explain what a Convertible bond is
A
- Unsecured loan stock that give the holder the option to convert the bond into ordinary shares in the issuing company
34
Q
Explain characteristics of convertible bond
A
- Interest payable until exercise (lower than normal)
- Conversion rights - length of conversion period differs, some on a monthly basis some just one date in future
- Number of shares differ through out term or can be fixed
- Returns to normal bond if not exercised
- Move in price with company share price
