Fixed Interest Investments

Question 1

What is a fixed interest Investment?

Answer 1

1. Issued by govts., companies and official bodies
2. carry a fixed rate of interest, known as the coupon
3. Have a fixed redemption value, known as the par value
4. Repaid after a fixed period, at the redemption date.
5. Cannot be cashed before
6. Can be traded on stock market
7. Interest usually paid 6 monthly

Question 2

What 3 things are included in bond titles?

Answer 2

1. Issuers Name
2. Coupon
3. Maturity Date

Question 3

How are bonds priced?

Answer 3

1. They have a par value of £100
2. They are traded above or below this at their nominal price

Question 4

How are bonds traded?

Answer 4

1. 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

Question 5

What is accrued interest on a bond? 2 Methods

Answer 5

1. Cum dividend: - Purchaser buys full 6 months interest
   - Pays clean price plus interest accrued to
   that point.
2. Ex dividend: - If bought within 7 days of interest payment
   - Purchaser pays clean price less interest
   from date of purchase to interest payment

Question 6

Name the 3 bond markets

Answer 6

1. Primary Market
2. Secondary Market
3. Bond Indices

Question 7

What is the Primary Bond Market

Answer 7

1. When bonds are bough for the first time
2. 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
3. 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

Question 8

What is the secondary bond market

Answer 8

1. Subsequent trading of bonds after primary market

Question 9

How are returns for bond expressed? and the 2 types?

Answer 9

1. As yields
   
   • Interest yield
   • Redemption yield

Question 10

Explain Interest Yield

Answer 10

1. the annual income from the bond as % of price investors would have to pay.
2. uses the clean price
3. coupon/clean price x 100

Question 11

Why can Interest Yield be confusing

Answer 11

1. As bond my produce capital gain/loss and that is not factored in

Question 12

Explain Redemption Yield

Answer 12

1. Takes into account both income and capital.
2. adjusts value of each payment for when it is received.
3. interest yield + [(gain or loss to maturity/no. years to maturity)/clean price] x 100

Question 13

Explain the relationship/differences between interest yield and redemption yield

Answer 13

1. if Redemption yield < interest yield there is a capital loss on redemption.

Question 14

Explain downsides to redemption yield

Answer 14

1. does not account for tax
2. one bond may trade near par but have lots of interest (taxable)
3. Another may have large capital gain (tax free on gilts + most corp. bonds) and low interest

Question 15

Explain index-linked bonds

Answer 15

1. Face value increases with index/inflation rate.
2. Need an assumption of interest rate when calc value.

Question 16

Risks with bonds (5)

Answer 16

1. Interest rate risk - when rising bond prices fall
2. Liquidity risk
3. Inflation risk
4. Currency Risk
5. Default Risk

Question 17

What factors affect bond prices?

Answer 17

1. when interest rates rise bond values fall
2. when interest rates fall bond prices increase
3. specific or commercial risks
4. market or systematic risks

Question 18

Explain specific or commercial risks and

Answer 18

1. the situation of the issuer of the bond
   e.g
   - creditworthiness of govt/company

Question 19

Explain credit ratings

Answer 19

1. Investment grade = BBB-/Baa3 to AAA
2. Non- investment grade = below BBB-/Bbb3

Question 20

Explain Market or Systematic Risks

Answer 20

1. Economic changes
2. Government Actions - eg. interest rate changes

Question 21

Explain volatility of a bond

Answer 21

1. Lower the coupon, more volatile
2. longer to redemption, more volatile

Question 22

What are bond yields useful for

Answer 22

1. comparing bonds of different maturities
2. indication of the markets expectation of interest rates
3. and the required future yields

Question 23

What does the Normal Yield Curve show

Answer 23

1. Investors demand higher yields for holding bond longer-term

Question 24

What is a yield curve?

Answer 24

1. shows yield on y axis vs. period to redemption on x axis

Question 25

What does a flat yield curve show?

Answer 25

1. When economic factors are stable
2. Investors accept lower yield and pay more for longer-dated bonds.

Question 26

What does an inverted yield curve show?

Answer 26

1. yield on long term bonds lower than short term
2. expectation that interest rates will fall in short term and be much lower in long term.

Question 27

Categories of Gilts

Answer 27

1. Shorts - <7 years (DMO) <5 years (financial press)
2. Mediums - 7-15 years (DMO) 5-15 (FP)
3. Longs - >15 years (DMO + FP)

Question 28

What is an Index linked gilt

Answer 28

1. coupon and capital move inline with RPI 3 months before payment
2. No CGT on disposal

Question 29

Explain Repo Market

Answer 29

1. one party agrees to sell gilts to another
2. Agreement to repurchase at agreed price in the future

Question 30

Name the 2 types of Corporate Bonds

Answer 30

1. Secured - charge vs. company assets
2. Unsecured

Question 31

Explain what a Debenture is

Answer 31

1. A secured loan between lender and borrower with business assets as security.
2. Agreement includes:
   
   • Interest Rate
   • Assets backing debenture (fixed or floating charge)
   • conditions on borrower eg. restricting amount of money company can borrow

Question 32

Explain Fixed and Floating Charges

Answer 32

1. Fixed charge - loan secured against assets that can be readily identified + cant be sold
2. Floating charge - loan vs. any company assets, can be sold and changed

Question 33

Explain what a Convertible bond is

Answer 33

1. Unsecured loan stock that give the holder the option to convert the bond into ordinary shares in the issuing company

Question 34

Explain characteristics of convertible bond

Answer 34

1. Interest payable until exercise (lower than normal)
2. Conversion rights - length of conversion period differs, some on a monthly basis some just one date in future
3. Number of shares differ through out term or can be fixed
4. Returns to normal bond if not exercised
5. Move in price with company share price