Lecture 6: Intro to Bonds & ZCB's

Question 1

ZCB source of investor returns?

Answer 1

ZCB’s are issued at a discount.

Difference between the issue price and par value at maturity

Question 2

Coupon bonds source of returns?

Answer 2

Issued at price = par value.

Return comes from coupon rates set just high enough to induce investors to pay par-value

Question 3

ZCB’s in the secondary market

Answer 3

Price is always at a discount, but can trader higher or lower than price at t=0

Question 4

Coupon bonds in secondary market

Answer 4

The price can be equal, below or above par value (due to changes in interest rates)

Question 5

Factors of complexity in fixed-income securities?

Answer 5

Maturity
Par-value
Provisions
Coupon Rate
Embedded Options

Question 6

Why is maturity important?

Answer 6

1. Yield offered on a bond depends on the term to maturity
2. Price volatility of a bond is a function of its maturity (among other variables)
   - The longer the maturity of a bond, the greater the price volatility resulting from a change in IR

Question 7

What are step-upnotes?

Answer 7

Bonds with a coupon rate that increases over time (single step up note or multiple step up note)

Question 8

What is a deferred coupon bond?

Answer 8

Bond whose interest payments are deferred for a specified number of years

Question 9

What is a floating rate bond?

Answer 9

Bonds that have coupon payments reset periodically according to a reference rate
Can include caps and floors on rates paid

Question 10

What is the BID price?

Answer 10

The price at which you can sell if you own an asset, or price you must pay to buy it

Question 11

What is the ASK price?

Answer 11

Price at which you can buy if you are a buyer, or the price you offer to sell if you own the asset

Question 12

What is a MARKET order?

Answer 12

Buy at lowest ASK or sell at highest BID

Only specify quantity

Question 13

What is a LIMIT order?

Answer 13

Specify quantity and price:

Buy at lowest ASK but ONLY if limit price hits an ASK PRICE
Sell at highest BID but ONLY if limit price hits a BID price

Question 14

How do these factors affect bond prices?

a) Par value
b) IR
c) T
d) d/prob of default
e) m/prob of recovery
f) R/recovery rate

Answer 14

a) Increase
b) Decrease
c) Decrease
d) Decrease
e) Increase
f) Increase

Question 15

Define CE

Answer 15

Economic value of the claim on the counterpart at the time of default

Question 16

Define LGD

Answer 16

Represents the fractional loss due to default which depends on Recovery Rate