Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Finance > Module 11: Money Market and Bonds > Flashcards

Module 11: Money Market and Bonds Flashcards

You may prefer our related Brainscape-certified flashcards:
Series 66 flashcards SIE Exam flashcards Series 63 flashcards Series 79 Top-Off Exam flashcards Series 7 Top-off Exam flashcards CFA flashcards Series 65 flashcards
1
Q

Three main sources of finance in the capital markets include:

A

Equity

Bonds - gov’t and corporate bonds

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Components of bonds

A 
Security 
Form
Coupon rate
Maturity 
Yield
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Security - bondholder can protect their investment using two-principal means

A
  1. Covenants - restrictions on disposing an asset or minimum interest cover ratio
  2. Security - fixed or floating charge over the assets of the company

NB// vast majority of bonds issued in the international markets are unsecured

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Bonds may be issued in which types of form?

A
  1. Registered - issued in many domestic markets and ownership registered by the issuer
  2. Bearer - ownership is not recorded by the issuer. Bearer of the physical certificate is assumed to be the legal owner
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Coupon

A

Interest payments on the bond % of par value and unaffected by market value (7% bond will also yield £7 interest annually)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Maturity

A

Amount the issuer agrees to repay on maturity.

Redemption can be at a discount or premium (Greater than or less than £100 par value)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Sinking funds

A

Partial repayment of the principal at regular intervals, usually yearly.

One benefit to investors = lowers the risk of default as company is reducing debt over time

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Yield

A

Measure of the return to the bondholder on their investment.

Not to be confused with coupon rate.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Interest yield formula

A

= I/P

I = nominal annual interest (coupon rate x nominal bond value)
P = current market price
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Redemption yield

A

Is the IRR calculation. It is the discount rate that equates the MV of the bond with the PV of interest and capital CFs.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

If the pre tax redemption yield was 10%, what would be the redemption yield including tax?

A

8%
10% x 0.8

(if tax was 20%)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Negative yield

A

If you buy a bond with a -ve yield, you pay more for the bond than you get back over the life of the investment

ECB overnight deposit rate cut to below zero => banks began to charge companies and pension funds with large cash balances for depositing their funds. Negative yield bonds became attractive as long as the -ve bond yield was less than the cost of having positive cash balances.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

Issuing bonds has 5 advantages:

A
  1. Funding diversification
  2. Covenants
  3. Speed
  4. Currency
  5. Flexibility
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Funding diversification

A

Enable a borrower to diversify funding away from the traditional bank lending sources.

Bond investors consist of investment institutions such as insurance companies, pension funds, corporations, money market funds, investment managers etc

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Covenants

A

Bonds generally have less onerous covenants for the borrower than other debt instruments

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Speed

A

Borrowers can capitalise swiftly on market trends by launching a bond within minutes of identifying funding opportunities (documentation can be prepared after the launch). More time consuming in other markets

Borrower can take advantage of low interest rates by making a bond issue when interest rates fall.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

Currency

A

Bonds can be issued in many different currencies => benefit to company seeking a particular currency for expansion for example

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

Flexibility

A

Bonds are flexible and thus can be tailored to the needs of the business and the investor.

e.g. they can be redeemable, irredeemable, fixed or variable coupon or convertible

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

Types of bonds

A
  1. Straight bonds
  2. Zero- coupon bonds
  3. Deep discount bonds
  4. Partly paid bonds
  5. Index-linked bonds
  6. Dual currency bonds
  7. Convertible bonds
  8. Bonds with equity warrants
  9. FRNs
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

Straight bonds

A

Fixed rate bond

Series of annual or semi-annual coupon payments

May have optional redemption prior to maturity

Coupon set at a level that enables the bonds to be issued at close to par value

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

Zero coupon bonds

A

Single fixed amount at maturity

No intermediate interest payments

Issued at a discount

Attractive to the issue as cash outflows only occur at maturity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

Deep discount bond

A

Annual coupon well below prevailing market rates

Issued at a discount to their par value

Attractive to the issuer as only small cash outflows before redemption

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

Partly-paid bonds

A

Only a portion (15-30%) of a partly paid bond is paid on issue with the balance payable at a later date (6-9mths)

If investors don’t pay the balance => forfeit their initial investment

Slightly lower yield to a fully paid bond

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

Index-lined bonds

A

Redemption value and interest payments are adjusted to take account of increases in appropriate price index over life of bond

e.g. retail price index

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

Dual currency bond

A

Right to redemption in one or other of two currencies at FIXED RATE OF EXCHANGE

Alternatively, bonds are denominated in one currency, interest coupons in that same currency but redeemable in another currency at a FIXED RATE OF EXCHANGE

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

Convertible bonds

A

converted at the investors’ option into a given number of OS.

Not obliged to so the bond may continue until redemption

Usual conversion price = 10-30% greater than the share price at the time of issues => investors can benefit from capital gains if market share price rises above conversion price

27
Q

Bonds with equity warrants

A

warrant entitles the holder to purchase a pre-determined number of OS at predetermined price

Warrant may be issued with a fixed-rate bond (host bond) and then physically detached and traded separately until they are exercised.

28
Q

FRNs

A

Floating rate notes
Fixed maturity
Interest coupon is adjusted at regular intervals with reference to LIBOR (usually for periods of 3-6mths)

Gov’t and financial institutions e.g. banks and building societies issue FRNs

29
Q

Call option

A

Allows the ISSUER to buy back the bond at par

e.g. if interest rates fell the issuer could buy back the bond and issue at the lower level of interest

30
Q

Put option

A

Allows the HOLDER to sell the bond back to the issuer at a particular price

e.g. if interest rates were to rise then the price of the bond would fall. Put option protects against this fall in price due to increased interest rates.

31
Q

The global bond market is comprised of

A

Domestic market
Foreign market
Eurobonds

Most corporate bonds trade in the over-the-counter (OTC) market = bond dealers/brokers trade debt securities over the phone or electronically

32
Q

Domestic bond markets

A

Bonds issued by companies in their own country in their own currency

Largely sold to domestic residents

33
Q

Foreign bond markets

A

Issued within the domestic market of the currency of denomination by non-resident borrowers.

E.g. British comp issues bonds in the US in dollars (= Yankee bonds)

E.g. German comp issues sterling-denominated bonds in the UK (=Bulldog bonds)

34
Q

Eurobond

A

Bond denominated in a currency which differs from that of the country of issue

e.g. Eurobond denominated in sterling but issued in the US = Eurosterling bond

35
Q

3 main avenues to issue bonds

A
  1. UK domestic bond market
  2. Eurobond
  3. Private Placings
36
Q

UK domestic bond market

A

Usual method by means of a BOUGHT DEAL

Bought deal

  • one or more lead managers commit to purchase/underwrite the entire issue.
  • only commit if confident their will be demand for the bonds
  • issue bought at fixed price or on a yield margin relative to a benchmarked gilt-edged stock
37
Q

Eurobond market

A

Eurobond issues are launched using the PLACING MECHANISM

Placing:

  • lead manager (usually bank) makes a firm offer to the issuer, specifying the structure of the issue and the all-in cost
  • acceptance by the issuer = binding contract for lead manager to launch eurobond on issuer’s behalf
  • lead manager invites a large number of other banks and investors to buy some of the bonds
  • lead manager is responsible for underwriting the issue and will try to obtain best price for the issuer

Note/ Bought deal - price is agreed at the start)

38
Q

Private placing

A

Bonds sold to private investors e.g. banks, insurance companies and pension funds

  • reduces regulation and speeds up the issuing process
  • applies to both UK domestic and eurobonds
39
Q

Pricing of the bond, 5 factors that affect the pricing of bond issues

A
  1. The gov’t yield (rf base)
  2. The credit rating - additional return over the gov’t yield to compensate for additional risk)
  3. The pricing of comparable issues
  4. the size and liquidity of the issue - larger more liquid issues can be issued at a lower yield
  5. The terms - e.g. embedded options
40
Q

Secondary market

A

After bond is issued, the bondholder may trade the bond on the secondary market - negotiability

trading above face value => trading at premium
below face value => trading at a discount

41
Q

Prevailing interest rate

A

Price of a bond on the secondary market will be linked to prevailing interest rates

42
Q

What is the link between bond prices and interest rates

A

When interest rates fall, price of bond rises

When interest rates rise, price of bond falls

P = I/r

43
Q

Expenses borne by issuer of bonds consist of:

A
  1. Issuer’s own professional advisor’s fees
  2. Manager’s legal and out of pocket expenses
  3. Stock exchange listing charges
  4. Principal paying agent’s fees
  5. Commission
  6. Trustee’s fee
  7. Printing costs for the offering circular and the bonds, if printed
44
Q

Credit ratings

A
  • issuer pays a credit rating agency to evaluate the credit risk on security being issued and award it a rating that reflects the credit quality
  • used by potential investors to do a credit evaluation themselves (useful when you don’t know the issuer)
  • rating applies to the security itself rather than the issuer
  • rate signifies the likelihood of default (missing interest payment or principal)
  • short-term ratings = less than a year e.g. bank deposits and commercial paper
  • long-term ratings = bonds and secured assets
45
Q

Rating criteria

A
  1. The economic environment
  2. The financial structure
  3. Forecasts, budgets and contingency plans
  4. Quality of mgmt
  5. The firm’s competitive position in the industry
  6. The industry
  7. Special features - allow for specific circumstances not covered in other criteria
46
Q

Optimum rating

A

Triple A = best rating

Optimal rating in terms of WACC = A

47
Q

Medium term notes (MTNs)

A
  • another form of corporate debt financing
  • maturities falling between those of commercial paper and corporate bond (270 days)
  • registered like corporate bonds however process is cheaper and more streamlined
  • MTN registration process allows issuers to offer on a continuous and periodic basis similar to commercial paper (instead of being underwritten by investment banks)
  • coupon-bearing instruments
  • not discounted
  • not secured
48
Q

The investors’ decision: investing in the short term, think…

A
  1. risk - likelihood of default by issuer, quality of security, higher credit rating=>lower risk than a speculative grade
  2. liquidity - secondary market considered for liquidity in regards to working capital mgmt
  3. return - reasonable low for bonds with high credit rating. Return for working capital mgmt is usually low.

Longer-term - return higher priority than liquidity

49
Q

Green bonds

A
  • bond to raise funds for new and existing projects with environmental benefits
  • ICMA says follow four criteria:
    1. Use of proceeds - on beneficial environmental projects
    2. Process for project evaluation and selection - clear targets disclosed
    3. Management of proceeds - funds = ring fenced and directly attributable to projects
    4. Reporting - regular and transparent

Tax free to the investor (interest and capital gains once sold)

50
Q

Relationship between interest rates, bond prices and required rate of return

A

As interest rates rise, required rate of return rises and bond price reduces

51
Q

6 money market instruments

A
  1. Interbank loan
  2. Certificate of deposit
  3. Gov’t bonds
  4. Commercial paper
  5. Repurchase agreements
  6. Money market funds
52
Q

Interbank loans

A

loans extended from one bank to another unaffiliated bank, normally across international borders

  • sometimes just taken out overnight in order for the borrowing bank to meet its regulatory reserve requirement
  • loan rate between banks form the LIBOR/LIBID rates
53
Q

LIBOR

A

borrowing

54
Q

LIBID

A

Investing rate

55
Q

Certificates of deposit

A

Fixed deposits - no way of trading investment and realising return until maturity

Investing in CDs removes the illiquidity as it is tradable

  • Negotiable CD offers a return a shade lower than fixed deposit rates because of the advantage of negotiability.
  • price at which CDs are traded = capital amount placed on deposit + interest earned up until the date of sale
56
Q

FRCDs

A

Floating rate Certificate of deposits

  • rate of interest is set at a pre-determined spread around LIBOR
  • quoted on the secondary market on a price plus accrued interest basis
57
Q

Gov’t bonds

A
  • used as a benchmark = everything else needs to be better than the gov’t bond return
  • maturity of 1 year or less
  • normally considered the safest possible investment
  • issued at a DISCOUNT and redeemable at par with no interest payable
58
Q

Commercial paper

A

ST debt obligation of a private sector company

  • usually issued in high amounts and are typically UNSECURED
  • maturity less than 9 months
  • common for issuers to roll over their paper, using the issues of one issue to repay the principal of previous issue
  • only corporations with a strong CREDIT REPUTATION can successfully issue commercial paper (well known, well trusted)
  • can be issued in international markets - sold outside the issuer’s country and is not denominated in the currency of the country in which it is issued
59
Q

Repurchase agreements (repos)

A
  • combination of two transactions - a sale and repurchase
  • first transaction = a bank sells securities (bonds or shares) it owns to an investor, agreeing to repurchase at a specified higher price at a future date.
  • second transaction (days or months later), the repo is ‘unwound’ as the bank buys back the securities from the investor
  • amount investor lends is less than the value of the securities => sufficient collateral if value of securities fall before bank repurchases them
60
Q

Risky repos (made up name)

A

If the investor believes the price of the securities will fall, can sell them and later repurchase equivalent securities to return to the bank just before repo is unwound

Extremely risky

61
Q

MOney market funds

A

standalone, pooled investment fund which actively invests in assets in a DIVERSIFIED PORTFOLIO of high grade, ST money market instruments

62
Q

Retail money market funds cater…

A

individuals

63
Q

Institutional money market funds serve…

A

corporations, foundations, gov’t agencies and other large investors

64
Q

Clearing house

A

settles the transaction by debiting the account of one party and crediting the account of the other

Finance (13 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions