L15 - Fixed Income Securities Flashcards
Who are the main issuers of bonds?
- US Treasury/Government •
- States, municipalities, and agencies
- Foreign governments (sovereign bonds) •
- Corporations
What are the different terms of bonds?
- Short (less than 1 yr)
- T-bills, CD’s, Commercial papers
- Long (more than 1yr)
- T-bonds, corporate bonds
- Consols
Price vs par value?
- par bond ( price = par value)
- discount (price < par value)
- Premium (price > par value)
Different coupons on bonds?
- Coupon rate: total annual interest payment per dollar face value
- Period (usually semi-annual)
- Fixed or variable (floaters and inverse floaters)
- Nominal or inflation-indexed (proportional to consumer price index -> real interest rate) • Possibly no coupons (zero-coupon bond)
Different currency denoted bonds?
Yankee bonds, Samurai bonds, Bulldog bonds, Eurobonds
• Gold-denominated
Credit Risk of bonds?
- Risk free
- Defaultable
- Ratings of bonds
- Moody’s, S&P, Fitch are rating companies
- High rating means low credit risk (A>B>C>D)
- Investment grade vs junk bonds
Different seniority of bonds and Covenants?
- Senior, sub-ordinated senior, junior…
- Secured by properties and equipment, other assets of the issuer, income-stream, etc
- Sinking fund provisions (sinkers)
- a way to mitigate risk for default for lenders –> firm has to pay back its loan in full in next 5 years instead agrees to buy back its loan on a rolling basis for the next 5 years –> at least the lenders are getting money over time instead of getting nothing at all if the firm goes bankrupt
Covenants –> Restrictions on additional issues, dividends, and other corporate actions.
Option provisions on bonds?
- Callability: After a certain period, issuer has the right to pay back the loan before it matures.
- Putability: After a certain period, bondholder has the right to demand payment of the loan before maturity.
- 8 Convertibility: After a certain period, bondholder had the right to exchange the bond for stocks of the issuer.
What is the general formula for YTM and price of a bond?
If the YTM is higher (or lower) than the coupon rate, then what must be true about the price?
– Higher YTM -> bond trades at a discount
– Lower YTM -> bond trades at a premium
How do you find the YTM on a semi-annual coupon bond?
- Find the semi-annual IIR rate that is the rate that solves the bond pricing equation
- Fine the YTM for the corresponding annual percentage rate
- e.g. for a semi-annual bond –> the APR is YTM =2r
- The corresponding effective annual yield is (1+r)2 = (1+ YTM/2)2 -1
YTM = yearly coupon rate if trading at par
Realised Returns vs. YTM?
- Suppose that you buy a bond.
- Will the return on your investment be equal to the YTM ?
- The return on your investment is equal to the YTM of the bond if :
- – you can re-invest the coupons at the same rate, and
- – you hold the bond until maturity
- The return on your investment is different from the YTM if :
- – you must re-invest the coupons at a different rate, or
- – you sell the bond before maturity at a price that corresponds to a different yield-to-maturity. (Market yields can change.)
How do you calculate holding period return?
Example of realised returns on a ZCB?
Example of realised returns on an annual paying coupon bond?
