LM 2: Fixed Income Markets Flashcards
What are the 3 types of common external loan financing instruments? LSF
- lines of credit
- secured loans
- factoring
Describe the 3 types of lines of credit. UCR
- Uncommitted Lines of Credit (may be recalled by the bank at any time, no cost other than interest charges.)
- Committed Lines of Credit (formal commitment, known as regular lines of credit.)
- Revolving Credit Agreements (aka revolvers) (formal legal agreements, similar to committed lines of credit just much larger amount)
Describe secured loans vs factoring?
- secured (asset-based) loans: (loans in which the lender requires the company to provide collateral in the form of an asset, a lien is filed against them)
- factoring: (companies sell their accounts receivable to a lender/ collection specialist at a discount)
Describe 3 characteristics of the 1 common type of external security-based financing instrument. FTR
commercial paper (CP):
- for larger more creditworthiness firms
-typically less than 3 months maturity then rolled over
-requires backup line of credit in case they cant issue more CP
What are demand deposits?
funds that are kept in checking accounts
What are operational deposits?
money received for providing clearing, custody, and cash management services for larger clients.
What is a savings deposit?
bank account that an individual can start to save money and earn interest for future use
What are certificates of deposit (CD’s)?
type of savings account offered by banks and credit unions where you agree to keep money in CD for a certain amount of time for a certain amount of interest
What’s the difference between a negotiable CD and a non-negotiable CD?
negotiable CD: sold on the euro bond market prior to maturity
non-negotiable CD: cannot be sold and penalty charged for early withdrawal
What can a bank do with a surplus of funds after meeting the minimum levels of cash reserves required by the central bank?
generate interest income by depositing any surplus funds with another bank that may need the cash to meet its reserve requirements
What is the central bank funds rate?
the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one another overnight
What can commercial banks do if they are unable to raise sufficient funds in the interbank market?
at last resort borrow from central banks discount window for a highest interest rate than the fed funds rate
What is an asset-backed commercial paper?
commercial paper backed by a credit facility (aka another bank)
What is the 2 step process of an asset-backed commercial paper?
- bank transfers some of its short-term loans to a special purpose entity (SPE) in exchange for cash
- SPE issues securities to investors who receive the right to the interest and principal payments
What is a repurchase agreement vs reverse repurchase agreement?
repo: party that sells securities for cash and then purchases it later.
reverse repo: party that buys the securities first then sells them back at repurchase price (or other end of a repo)
party “sells” a security for a purchase price and agrees to buy it (or a similar security) back later at a higher amount, known as the repurchase price
What is the repurchase price formula?
repurchase price = purchase price * [1 + (repo rate * (days in repo term/360))]
What is a master repurchase agreement?
template for negotiations of repos
Whats the difference between overnight repo and term repos?
overnight repo: one-day maturity
term repos: longer than one day until maturity
What does the initial margin mean for repos and what is the formula?
means how collateralized the loan is. greater than 100% means over-collateralized
initial margin = security price/purchase price
What is the haircut for repos mean and what is the formula?
the return earned for doing the repo
haircut = security price - purchase price/security price
What is the variation margin for repos mean and what is the formula?
the amount of funds needed to ensure margin levels for repos. negative means you cant request money back and positive money means you owe more money
variation margin = (initial margin * purchase price t) - security price
What is the difference between general collateral repo and special collateral repo?
general collateral repo: choose among a basket of securities
special collateral repo: delivery of a particular security
Describe the 5 key factors influencing repo rates. MCRCC
- money market interest rates (lower repo rate if lower financing rates)
- collateral quality (riskiness or credit rating)
- repo term (length)
- collateral uniqueness (high demand or low demand effects rate)
- collateral delivery (delivery of securities to lender will lower repo rate)
What are 5 risk associated with repurchase agreements? DCMLN
- default risk
- collateral risk
- margining risk (cash flows smaller than expected)
- legal risk
- netting & settlement risk
What is the difference between bilateral repo transactions and triparty repo transactions?
bilateral: Party A deals with Party B
trilateral: Party A deals with Party B; except a custodian holds the cash and securities and provides custodian services
Why do investors require higher yields for longer-dated bonds?
due to the various unknown risks between inception and maturity, specifically price risk, interest rate risk, etc.
What are fallen angels?
debt that has previously been rated IG when issued but has been downgraded to high yield.
What is sovereign debt?
debt issued by the government of an independent political entity, usually in the form of securities.
What is external debt?
debt obligations owed to foreigners
Who are the holders of emerging market debt?
domestic investors and financial instiutions
How do emerging markets attract investors?
they issue debt obligations denominated in more widely-traded foreign currencies such as the euro or the US dollar
What is the Ricardian equivalence theorem?
An increase in government spending that increases the budget deficit would lead to a corresponding decrease in consumption expenditure, as households save more in anticipation of their future tax liability. The net effect on aggregate demand then is zero and fiscal policy is entirely ineffective.
How is sovereign debt typically issued?
through public auctions that are run by the country’s Treasury or Finance Ministry
What is the difference between a competitive bid and a noncompetitive bid?
competitive bidders: specify the maximum price that they are willing to pay
non-competitive bidders: agreeing to accept the price that is determined by the auction
What is single-price auction?
all selected bids (both competitive and non-competitive) pay the same price.
all non competitive bids are accepted
What is the stop yield?
the yield on the lowest price competitive bid that is accepted in a single price auction
What is a multiple-price auction?
each competitive bidder that is accepted pays the price that they have bid.
Where is sovereign debt traded after it has been issued in the primary market?
traded over-the-counter (OTC) by broker/dealers in secondary markets
Whats the difference between on the run and off the run sovereign debt?
off the run: securities from previous issues
on the run: most recent issue of securities
What is reserve currency?
reserve currency is a large amount of currency held by central banks and major financial institutions to use for international transactions.
What are quasi-government bonds (agency bonds)?
a bond issued by a business entity that provides specific governmental services (eg. Federal National Mortgage Association)
What are general obligation (aka GO) bonds?
fund public goods and services in the non-sovereign’s limited jurisdiction and are repaid from local tax cash flows.
What are revenue bonds?
bonds issued to fund a specific project backed by the projects revenue (eg. Toll roads)
Who can issue general obligation bonds and revenue bonds?
local and regional government authorities
What is a supranational agency?
An international organization that represents a country or more (eg. United Nations)
How do Governments minimize interest rate and rollover risks when issuing securities?
by distributing debt across maturities while issuing debt in regular, predictable intervals
