(R44) Introduction to Fixed-Income Valuation Flashcards

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1
Q

Calculate a bond’s price given a market discount rate

A

The price of a bond is the present value of its future cash flows, discounted at the bond’s yield-to-maturity (use time value of money keys)

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2
Q

Discount or premium bond when coupon rate < YTM

A

Discount bond; premium bond is when coupon rate > YTM

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3
Q

Identify relationship among bond price and discount rate

A

Bond price is inversely related to the discount rate; when price goes up, rate goes down (this is called the inverse effect)

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4
Q

What is the convexity effect relationship for bond price?

A

Given the same coupon and time to maturity, the % change in price is greater when rates are decreasing compared to when rates in increases

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5
Q

What is the coupon effect relationship for bond prices?

A

Lower coupon bond is more price sensitive than a higher coupon bond when rates change, given the same time to maturity

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6
Q

What is the maturity effect relationship for bond prices?

A

For the same coupon rate: a longer term bond is more price sensitive than a shorter-term bond

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7
Q

Spot rate and calculation of PV using spot rates

A

Spot rates are market discount rates for single payments to be made in the future (each payment in the future has a different rate); PV = [PMT/(1+S1)] + [PMT/(1+S2)] + [PMT/(1+Sn)]

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8
Q

When a bond is between coupon dates, its price has two parts:

A

1) the flat price (PVflat) and 2) accrued interest (AI); the sum of these equal PVfull

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9
Q

Formula to calculate accrued interest for bonds

A

Accrued interest = t/T x PMT (where t = # of days between last payment and settlement date; T = # of days between each payment)

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10
Q

Two conventions to count days for calculating accrued interest and PVfull

A

30/360 (used for corporate bonds) and actual/actual (used for gov’t bonds)

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11
Q

Formula for PVfull

A

PVfull = PV x (1+r)^(t/T)

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12
Q

Matrix pricing

A

Matrix pricing is a method used to estimate the yield-to-maturity for bonds that are not traded or infrequently traded. The yield is estimated based on the yields of comparable bonds (i.e. similar tenor, coupons, credit quality).

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13
Q

Difference between effective annual rate and semi-annual bond basis yield

A

Effective annual rate is for bonds with a periodicity of 1 (1 coupon/year); Semi-annual bond basis yield is for bonds with a periodicity of 2 (2 coupons/year).

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14
Q

Relationship between periodicity and annual percentage rate

A

As periodicity increases, APR decreases

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15
Q

Formula for periodicity conversions (semi to quarterly)

A

[1 + (r/2)]^2 = [1+(r/4)]^4

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16
Q

Define bond yields that follow street convention and true yields.

A

Bond yields that follow street convention use the stated coupon payment dates (ignores weekend/holidays). A true yield accounts for coupon payments that are delayed by weekends or holidays and may be slightly lower than a street convention yield.

17
Q

Define yield-to-call and yield-to-worst.

A

For a callable bond, a yield-to-call may be calculated using each of its call dates and prices. The lowest of these yields and YTM is a callable bond’s yield-to-worst.

18
Q

Define government equivalent yield

A

Quoted for a corporate bond
Restates 30/360 to actual/actual
Results in a more accurate spread over benchmark measure

19
Q

Define floating rate notes

A

interest payments are not fixed. They vary from period to period depending on the current level of a reference interest rate. The reference rate is usually a short-term money market rate (i.e. Libor). Intent of FRN is to offer a security with less market price risk than a fixed-rate bond.

20
Q

Define quoted margin and required margin for floating rate notes

A

Quoted Margin: the yield spread over the reference rate; this is credit related and may be negative.
Required Margin/discount margin: spread required by investors to reflect changes in credit quality; changes usually come from changes in the issuer’s credit risk

21
Q

Describe relationship between quoted margin, required/discount margin and PV

A

PV of floating rate note is > 100 when QM>DM

22
Q

Calculate price of floating-rate note (PV)

A

Use time value of money keys: PMT=[(index + QM)/m] x 100; index is libor

23
Q

Define money market instruments

A

Money market instruments are annualized but not compounded. For money market instruments, yields may be quoted on a discount basis or an add-on basis

24
Q

Formula for two yield measures for money market instruments

A

Discount Rate => PV = FV x [1 - (days/yr) x DR]
DR = (yr./days) x (FV - PV) / FV
Add-on rates => PV = FV / [1 - (days/yr) x AOR]
AOR = (yr./days) x (FV - PV) / PV

25
Q

Define yield curve

A

A yield curve (aka maturity structure or term structure of interest rates) shows the term structure of interest rates by displaying yields for a particular cluster of bonds (Same currency, liquidity, credit risk, tax status, and coupon)

26
Q

Define spot curve

A

The spot curve includes YTMs for zero-coupon bonds for a full range of maturities (sometimes called the zero or strip curve)

Normal yield curve is upward sloping => longer maturities have higher YTMs

27
Q

Define par carve

A

Sequence of YTMs such that each bond is priced at part. Par rates are derived from spot rates

28
Q

Define a forward curve

A

A forward curve is a yield curve composed of forward rates, such as 1-year rates available at each year over a future period. Rates agreed on today, received/paid in the future; Forward curve is a mathematical result of the spot curve

29
Q

Compare the curves when looking at them on a graph

A

When all curves are upward sloping (Forward > spot > par); When all curves are downward sloping (Forward < spot < par)

30
Q

What does f(2,5) mean?

A

2 years from now, 5 year rate

31
Q

Given a spot curve, what kind of curve can be derived?

A

Forward curve

32
Q

Define forward rate and calculate the implied forward rate from a spot rate

A

Interest rate on a bond or money market instrument traded in a forward market (aka break-even rates or no-arbitrage rates). rates agreed on today but received/paid in the future

Ex: 3y1y means this begins in 3 years and lasts 1 years; f (3,1)

Spots: 3yr. = 3.615%; 4yr = 4.18%

Implied forward rates are calculated from spot rates using the following formula:

[1 + (.0418/2)]8 = [1 + (.0365/2)]6 [1 + (f(3,1)/2)2 we are solving for f(3,1)

33
Q

What is a yield spread?

A

A yield spread is the difference between a bond’s yield and a benchmark yield or yield curve.

34
Q

What is a zero-volatility spread (Z-spread)

A

A constant spread over a government spot curve (or swap curve)

35
Q

Yield measures typically are annualized and compounded if they mature when?

A

Greater than 1 year

If maturity is less than a year, then they only annualize but no compounding

36
Q

What is a G-spread

A

A G-spread is the difference between a bond’s yield and a benchmark yield or yield curve where the benchmark is a government bond yield.

37
Q

What is an I-spread

A

An I-spread is the difference between a bond’s yield and a benchmark yield or yield curve where the benchmark is a interest swap rate. I-spread is more risky