LM 2: Fixed Income Markets

Question 1

What are the 3 types of common external loan financing instruments? LSF

Answer 1

1. lines of credit
2. secured loans
3. factoring

Question 2

Describe the 3 types of lines of credit. UCR

Answer 2

1. Uncommitted Lines of Credit (may be recalled by the bank at any time, no cost other than interest charges.)
2. Committed Lines of Credit (formal commitment, known as regular lines of credit.)
3. Revolving Credit Agreements (aka revolvers) (formal legal agreements, similar to committed lines of credit just much larger amount)

Question 3

Describe secured loans vs factoring?

Answer 3

1. 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)
2. factoring: (companies sell their accounts receivable to a lender/ collection specialist at a discount)

Question 4

Describe 3 characteristics of the 1 common type of external security-based financing instrument. FTR

Answer 4

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

Question 5

What are demand deposits?

Answer 5

funds that are kept in checking accounts

Question 6

What are operational deposits?

Answer 6

money received for providing clearing, custody, and cash management services for larger clients.

Question 7

What is a savings deposit?

Answer 7

bank account that an individual can start to save money and earn interest for future use

Question 8

What are certificates of deposit (CD’s)?

Answer 8

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

Question 9

What’s the difference between a negotiable CD and a non-negotiable CD?

Answer 9

negotiable CD: sold on the euro bond market prior to maturity

non-negotiable CD: cannot be sold and penalty charged for early withdrawal

Question 10

What can a bank do with a surplus of funds after meeting the minimum levels of cash reserves required by the central bank?

Answer 10

generate interest income by depositing any surplus funds with another bank that may need the cash to meet its reserve requirements

Question 11

What is the central bank funds rate?

Answer 11

the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one another overnight

Question 12

What can commercial banks do if they are unable to raise sufficient funds in the interbank market?

Answer 12

at last resort borrow from central banks discount window for a highest interest rate than the fed funds rate

Question 13

What is an asset-backed commercial paper?

Answer 13

commercial paper backed by a credit facility (aka another bank)

Question 14

What is the 2 step process of an asset-backed commercial paper?

Answer 14

1. bank transfers some of its short-term loans to a special purpose entity (SPE) in exchange for cash
2. SPE issues securities to investors who receive the right to the interest and principal payments

Question 15

What is a repurchase agreement vs reverse repurchase agreement?

Answer 15

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

Question 16

What is the repurchase price formula?

Answer 16

repurchase price = purchase price * [1 + (repo rate * (days in repo term/360))]

Question 17

What is a master repurchase agreement?

Answer 17

template for negotiations of repos

Question 18

Whats the difference between overnight repo and term repos?

Answer 18

overnight repo: one-day maturity

term repos: longer than one day until maturity

Question 19

What does the initial margin mean for repos and what is the formula?

Answer 19

means how collateralized the loan is. greater than 100% means over-collateralized

initial margin = security price/purchase price

Question 20

What is the haircut for repos mean and what is the formula?

Answer 20

the return earned for doing the repo

haircut = security price - purchase price/security price

Question 21

What is the variation margin for repos mean and what is the formula?

Answer 21

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

Question 22

What is the difference between general collateral repo and special collateral repo?

Answer 22

general collateral repo: choose among a basket of securities

special collateral repo: delivery of a particular security

Question 23

Describe the 5 key factors influencing repo rates. MCRCC

Answer 23

1. money market interest rates (lower repo rate if lower financing rates)
2. collateral quality (riskiness or credit rating)
3. repo term (length)
4. collateral uniqueness (high demand or low demand effects rate)
5. collateral delivery (delivery of securities to lender will lower repo rate)

Question 24

What are 5 risk associated with repurchase agreements? DCMLN

Answer 24

1. default risk
2. collateral risk
3. margining risk (cash flows smaller than expected)
4. legal risk
5. netting & settlement risk

Question 25

What is the difference between bilateral repo transactions and triparty repo transactions?

Answer 25

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

Question 26

Why do investors require higher yields for longer-dated bonds?

Answer 26

due to the various unknown risks between inception and maturity, specifically price risk, interest rate risk, etc.

Question 27

What are fallen angels?

Answer 27

debt that has previously been rated IG when issued but has been downgraded to high yield.

Question 28

What is sovereign debt?

Answer 28

debt issued by the government of an independent political entity, usually in the form of securities.

Question 29

What is external debt?

Answer 29

debt obligations owed to foreigners

Question 30

Who are the holders of emerging market debt?

Answer 30

domestic investors and financial instiutions

Question 31

How do emerging markets attract investors?

Answer 31

they issue debt obligations denominated in more widely-traded foreign currencies such as the euro or the US dollar

Question 32

What is the Ricardian equivalence theorem?

Answer 32

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.

Question 33

How is sovereign debt typically issued?

Answer 33

through public auctions that are run by the country’s Treasury or Finance Ministry

Question 34

What is the difference between a competitive bid and a noncompetitive bid?

Answer 34

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

Question 35

What is single-price auction?

Answer 35

all selected bids (both competitive and non-competitive) pay the same price.

all non competitive bids are accepted

Question 36

What is the stop yield?

Answer 36

the yield on the lowest price competitive bid that is accepted in a single price auction

Question 37

What is a multiple-price auction?

Answer 37

each competitive bidder that is accepted pays the price that they have bid.

Question 38

Where is sovereign debt traded after it has been issued in the primary market?

Answer 38

traded over-the-counter (OTC) by broker/dealers in secondary markets

Question 39

Whats the difference between on the run and off the run sovereign debt?

Answer 39

off the run: securities from previous issues

on the run: most recent issue of securities

Question 40

What is reserve currency?

Answer 40

reserve currency is a large amount of currency held by central banks and major financial institutions to use for international transactions.

Question 41

What are quasi-government bonds (agency bonds)?

Answer 41

a bond issued by a business entity that provides specific governmental services (eg. Federal National Mortgage Association)

Question 42

What are general obligation (aka GO) bonds?

Answer 42

fund public goods and services in the non-sovereign’s limited jurisdiction and are repaid from local tax cash flows.

Question 43

What are revenue bonds?

Answer 43

bonds issued to fund a specific project backed by the projects revenue (eg. Toll roads)

Question 44

Who can issue general obligation bonds and revenue bonds?

Answer 44

local and regional government authorities

Question 45

What is a supranational agency?

Answer 45

An international organization that represents a country or more (eg. United Nations)

Question 46

How do Governments minimize interest rate and rollover risks when issuing securities?

Answer 46

by distributing debt across maturities while issuing debt in regular, predictable intervals