Quiz #1 Flashcards
Fixed income securities fall under either:
debt obligations or preferred stock
debt obligations include
bonds, morgage-backed securities, asset-backed securities, and bank loans
key features of a bond
coupon rate, face value, and maturity
affirmative covenants
set forth what the borrower needs to do
tenor vs maturity
tenor: residual life of bod or in other words the number ofyears left until final prinicpal payments, maturity is the stated lifetime of the bond
par value
what issuer agrees to pay back at or by maturity date
par value =
100
coupon rate =
interest rate
that the issuer agrees to pay each year
spot rate =
yield on treasury zero-coupon bond
step-up =
coupon rates increasing overtime
deffered coupon bond
no int payment until bond matures
floating rate
rate resets over period of time
coupon rate =
reference rate + quoted margin
coupon int paid every
6 months
embedded options are:
the right to call, the right of borrowers in a pool of loans to prepay principalearly, accelerated sinking fund provisions, cap on a floater
most common embedded options:
conversion priviliage, right to put, floor on a floater
accelerated sinking fund provision allows the
issuer:
to retire more than the amount stipulated to
satisfy the periodic sinking fund requirement.
A convertible bond is an issue that allows the investor
right to convert the bond into a specified number of
shares of common stock
Foreign bond:
bond issued in a host country’s
financial market, in the host country’s currency, by
a nonresident corporation (e.g. Toyota issuing US
dollar denominated bonds in the US)
straight fixed rate bond
int and principal paid with different currencies
But why they (currency option bonds) exist since the investor may replicate the position by
buying a currency option?
Currency Option Bonds
ANSWER: because the durations with currency-option
bonds are usually much longer than afforded by options
(only a few months).
Valuation is done by breaking down the bond into a
straight bond in currency X and an option to swap a
bond in currency X for another of same rate in currency
Y at an a priori set exchange rate of X:Y
Currency Option Bonds
asset evaluation involves:
estmating cash flows, determining int rate used to discount flows, calaute present values of those cash flows using the int rates
if rates fall far enough:
issuer will refinance, and borrower has incentive to refinance
on the run
minimum int rate
interest rate is the same as
yield
coupon rate = market yield=
coupon rate <market>market yield =</market>
par value
discount
premium
traditional bond evaluation
iscount
every cash flow of a security by the same interest
rate (or discount rate), thereby incorrectly viewing
each security as the same package of cash flows.
arbitrage-free approach
values a bond as a
package of cash flows, with each cash flow viewed
as a zero-coupon bond and each cash flow
discounted at its own unique discount rate
credit spreads increase with
maturity
bond prices and yields are ______ _________
inversely related
cash flows do not change for int rates, this does not apply for :
cmo, callable bonds, loss reserves
A call option has the following effects on the price of the option-free bond
At high interest rates, the call option has almost no value (very unlikely to be
exercised).
* The price behaves at this point like an option-free bond
* As interest rates decrease, the call option takes on negative value because it is more
likely to be called.
* The price behaves at this point differently than an option-free bond
YTC is obtained b
replacing maturity with the time
until the call is first possible, and replacing the par
value with call price
When interest rates are far higher than coupon rate, duration is:
When interest rates drop, duration reduces because:
- Sometimes callable bond prices are slightly above the call price
because :
almost identical to that of a straight bond.
the price
of the bond will increasingly be asymptotic to the call value.
the company doesn’t call and they enjoy a higher
coupon rate. In that case duration becomes negative.
