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
What does a flat yield curve show?
1. When economic factors are stable
2. Investors accept lower yield and pay more for longer-dated bonds.
26
What does an inverted yield curve show?
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.
27
Categories of Gilts
1. Shorts - <7 years (DMO) <5 years (financial press)
2. Mediums - 7-15 years (DMO) 5-15 (FP)
3. Longs - >15 years (DMO + FP)
28
What is an Index linked gilt
1. coupon and capital move inline with RPI 3 months before payment
2. No CGT on disposal
29
Explain Repo Market
1. one party agrees to sell gilts to another
2. Agreement to repurchase at agreed price in the future
30
Name the 2 types of Corporate Bonds
1. Secured - charge vs. company assets
2. Unsecured
31
Explain what a Debenture is
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
32
Explain Fixed and Floating Charges
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
33
Explain what a Convertible bond is
1. Unsecured loan stock that give the holder the option to convert the bond into ordinary shares in the issuing company
34
Explain characteristics of convertible bond
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
