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FM 212 > MT (3-4) Fixed Income > Flashcards

MT (3-4) Fixed Income Flashcards

1
Q

What is the Par Value of a bond? (Also known as Face value or Principal)

A

The nominal value of the bond that is repaid to the bondholder at maturity.

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2
Q

What is a bond coupon?

A

The periodic payment of interest on a bond. Generally fixed (can have floating rate bonds).

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3
Q

How do you calculate the annual coupon of a bond?

A

par value X coupon rate

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4
Q

What is the Coupon rate?

A

The annual coupon payment expressed as a percentage of the bond’s par value.

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5
Q

What is the Maturity date of a bond?

A

The specified date on which the par value of the bond must be repaid.

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6
Q

What is a zero coupon bond? (AKA pure discount bond)

A

A bond that pays no annual interest (coupons) but is sold below par so all the compensation is paid to the zero coupon bondholder in the form of capital appreciation.

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7
Q

What is a coupon bond?

A

A bond that pays regular coupon interest payments up to maturity, when the par value is also paid.

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8
Q

When is a bond said to be trading at a discount?

A

A bond trading below it’s par value

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9
Q

When is a bond said is said to be trading at a premium.?

A

A bond trading above it’s par value

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10
Q

What is the Yield to Maturity?

A

The YTM is the constant, hypothetical discount rate that, when used to compute the PV of a bond’s cash flows, gives you the bond’s market price as the answer.

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11
Q

What is the relationship between bond price and Yield to Maturity?

A

A higher bond price must mean a lower YTM and vice versa.

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12
Q

How do you calculate the Market Price of a bond?

A

Find the NPV of all cash flows using the YTM as the discount rate

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13
Q

What is the relationship between bond prices and interest rates?

A

Bond prices are negatively related to interest rates.

If interest rates go up, cash flows are discounted more heavily, and the price (PV) goes down.
If interest rates go down, cash flows are discounted less heavily, and the price (PV) goes up.

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14
Q

What is a common stock?

A

Security representing a share in the ownership of a corporation.

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15
Q

What is an IPO?

A

The first sale of stock in a corporation to the public.

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16
Q

What is a secondary market?

A

A market, often a stock exchange, in which previously issued shares are traded amongst investors.

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17
Q

What is a dividend?

A

Payments made by companies to shareholders. These are usually ex-ante (forecasts) uncertain (unlike bond coupons).

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18
Q

What is a dividend yield?

A

Ratio of annual dividend to share price.

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19
Q

What is a P/E ratio?

A

Share price divided by earnings per share

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20
Q

What is the market value of a company?

A

The total stock market value of the firm’s stock (i.e. price per share multiplied by number of shares outstanding).

21
Q

What is the Book Value of a firm?

A

Accounting value of the firm’s equity as reflected on the company’s balance sheet.

22
Q

What is the liquidation value of a firm?

A

The amount that would be available to shareholders if the firm was liquidated and all creditors paid off.

23
Q

Give the formula for Measuring expected return to holding a share

A

E(r) = Expected dividend yield + expected capital appreciation

24
Q

What is the stock pricing equation?

A

P=∑E0(Dt)/(1+E(r))^t starting at t =1 and ending a t is infinity

25
Q

What is the stock price formula, for a stock that pays out constant dvidends starting one period after the point of valuation?

A

P(0)=D/E(r) (Use the same formula as perputuity)

26
Q

What is the formula for Stock Prices when Dividends Grow at a Constant Rate and start one period after the point of valuation?

A

P(0) = D/ E(r) - g (same formula as perputiuity with growth)

Also known as the gordon growth formula for stock pricing

27
Q

What is the payout ratio?

A

The ratio of dividends to earnings

28
Q

What is the plowback ratio?

A

Proportion of earnings retained by the firm and used

for investment.

29
Q

What is the return on equity?

A

It is a measure of the amount of earnings that a pound of

equity (book value) creates. ROE=EPSt/Book value of equity per share t-1

30
Q

What is the formula for a firms earning growth rate?

A

g=ROE X plowback ratio

ROE = EPSt/Book value of equity per share t-1

31
Q

If the payout ratio i.e. (1 – plowback ratio), and ROE are constant, what is the dividend growth rate?

A

Dividend growth rate= ROE X plowbak ratio

ROE = EPSt/Book value of equity per share t-1

32
Q

What is the Present Value of Growth Opportunities

(PVGO)?

A

The difference in value between the firm that plows back earnings and the firm that does not

33
Q

Why are E/P ratios not a good measure of required returns?

A

They will dramatically understate required returns for firms with large PVGO. Lesson, don’t use E/P ratios to estimate required returns unless you adjust for growth.

34
Q

What is the spot interest rate?

A

The spot interest rate (denoted by rt ) is the interest rate fixed today on a loan that is made today over a specified time period t. Spot rates are quoted as annual rates.

35
Q

What rate is used to price government bonds?

A

The spot rate

36
Q

What is arbitrage?

A

An investment strategy that has a positive cash flow today and zero cash flows in the future in all states of nature.

37
Q

Describe the process of short selling a bond?

A

Steps:
Date 0: Borrow the bond from a broker and sell the bond in the market.

Between dates 0 and 1: Compensate the broker for any coupons the bond pays.

Date 1: Buy the bond in the market and return the bond to the broker.

A short sale is profitable if the bond price goes down.

38
Q

What does the Macaulay duration formula show?

A

The Macaulay Duration is simply a weighted average of the years in which the bond pays its cash flows.

39
Q

What is the formula for Maccauly duration?

A

Dmac = ∑(t)x Wt from t=1 to t=n

Wt = [Ct / (1+y)^t / pv of bond]

Ct here represents the cashflow at time t.

y is the yield quoted as an effective annual rate

PV of bond = ∑ Ct / (1+y)^t from t=1 to t=n

40
Q

What is the formula for Modified Duration?

A

Dmod= Dmac/ (1+y)

41
Q

What is Modified duration used for?

A

This measure is useful as it can be employed to give approximate percentage changes in the price of a bond for a known change in yields.

42
Q

How do you measure the Sensitivity of Bond Prices to Interest Rates (Hint: use Modified Duration)

A

-Dmod(P) = dP (Change in bond price) / d(1+Y) (change in yield)

∆P≈−Dmod (P)(∆y)

This a linear approximation for the change in the price of one unit of the bond for a small change in the yield.

43
Q

Are short or long dated bonds more sensitive to yield changes?

A

Prices of long term bonds are more interest rate sensitive than prices of intermediate term bonds all else equal.

44
Q

What is the forward interest rate?

A

The forward interest rate (denoted by f) is the interest rate fixed today on a loan to be made in the future over some specified future period agreed today.

45
Q

What is the spot rate/ forward rate no arbitrage formula

A

(1+r(t))^t x (1+ tF(T))^T = [1+r (t+T)]^t+T

46
Q

What is a term structure?

A

A term structure is a mapping between maturities and spot rates at those maturities. Graphically, it is a plot of spot rates on the y-axis against maturities on the x-axis.

47
Q

What is the typical term structure shape?

A

the UK term structure is upward sloping (i.e. spot rates for longer maturities are greater than those for smaller maturities). This is the normal state of affairs.

But this is not always true: sometimes term structures slope downwards, sometimes they are flat, sometimes they are hump-shaped.

48
Q

What determines the shape of the term structure?

A

􏰀 Unbiased Expectations Theory
(i.e. term structure slope reflects expected future interest rate changes)
􏰀 Liquidity Premium Theory
(notion that savers have a preference for short term securities over long term securities. long term securities must offer a larger average return than short term ones)
􏰀 Market Segmentation Hypothesis
No link between the two segments means no link between equilibrium long and short rates.
Outcome is that the term structure can look whichever way you want it to.

FM 212 (12 decks)

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