RB CH14 - Bond Fundamentals

Question 1

Define the mechanics of a bond.

Answer 1

A fin.inst. that promises that the issuer (borrower) will pay the holder (investor) interest (coupon) and will repay the principal amount over a specified fixed period.

Question 2

What is a GILT?

Answer 2

Bond issued by Govt. (typically the Bank of England and some other commonwealth countries)

Question 3

What is the difference between Bearer Bonds and Registered Bonds?

Answer 3

Registered bond has its owner registered with issuer (details of owner kept).

Bearer bond owned by holder of physical bond. Coupons redeemed by submission of physical coupons.

Question 4

What is the difference between Bearer Bonds and Registered Bonds?

Answer 4

Registered bond has its owner registered with issuer (details of owner kept).

Bearer bond owned by holder of physical bond. Coupons redeemed by submission of physical coupons.

Question 5

Consider the relationship of the market interest rate and the coupon rate of a particular bond. Give the different scenarios possible.

Answer 5

Mkt i > coupon i : bond sells at discount

Mkt i < coupon i : bond sells at premium

Mkt i = coupon i : bond sells at mkt val.

Question 6

What is the primary characteristic of the relationship between yields (interest rates) and bond prices? Consider why this the case.

Answer 6

Inverse relationship due to the structure of bonds. If yields were to rise above the yield of a particular bond then the bond price must reduce in order to increase it’s ytm to a competitive level.

Question 7

What is a secured (senior) bond?

Answer 7

Bond that is backed by a legal claim on specified property

Question 8

What is an unsecured bond (debenture)?

Answer 8

Bond backed only by issuer’s promise to pay interest and principal on timely basis
i.e. secured by general credit of issuer

Question 9

What is a subordinated (junior) debenture?

Answer 9

Posses a claim on income and assets that is subordinated to other debentures

Question 10

What is the indenture? Who ensures it’s provisions are met?

Answer 10

An indenture is the contract between issuer and holder specifying the legal requirements.
A trustee ensures it’s provisions are met

Question 11

What is a non-refunding provision?

Answer 11

Prohibits a call and premature retirement of an issue if you are going to refinance with proceeds from a lower coupon bond

Question 12

Who are the participating ISSUERS of the global bond-market structure?

Answer 12

Sovereigns
Quasi govt (agencies) or foreign govt.
Securitized/collateralize issues
Corporations
High-yield/emerging markets

Question 13

Who are the participating INVESTORS of the global bond-market structure?

Answer 13

Individuals (minor)
Institutional
- Life insurance co.
- Com. Banks
- property and liability insurance companies
- pension funds
- mutual funds

Question 14

What is the primary question in bond credit analysis?

Answer 14

Can the issuer service its debt timeously over the life of the issue

Question 15

What is the difference between a foreign bond and a eurobond?

Answer 15

Foreign: bond sold in one country and currency by a borrower of different nationality
e.g. Yankee bonds
Samurai bonds
Eurobond: bond underwritten by an international syndicate and sold in several national markets
e.g. Euroyen bonds
Eurodollar, Eurosterling

Question 16

What is a mortgage bond?

Answer 16

Grants holder lien on some piece of issuer property (good security)

Question 17

What is an equipment trust certificate?

Answer 17

Large transportation firms use proceeds to purchase equipment which also serve as collateral

Question 18

What is a collateral trust bond?

Answer 18

Pledge fin.ass.

Question 19

What is a CMO?
Do investors own the CMO directly?
What serves as collateral for the CMO?

Answer 19

CMO is a special purpose entity that owns and administers the mortgage loans
by receiving the home owner’s payments and passing them on to investors.
The investors don’t own the CMO directly but own bonds issued by the CMO.
Mortgage loans underlying CMO serve as collateral for the investor owned bonds

Question 20

Define CDO.

What do banks use them for (other than making money)?

Answer 20

A Collateralized debt obligation is a structured fin. product backed by a pool of loans (hence ‘collateralized’)
Banks use them to transfer the risk to the investor by creating tranches to sell.

Question 21

Identify the 3 most important determinants of the price of a bond. Describe the effect of each

Answer 21

Market Interest rates (inverse relationship)
Time to maturity (direct relationship)
Coupon (direct relationship)

Question 22

What does bond price volatility depend on?

Answer 22

Coupon and maturity; longer maturity and lower coupons are much more volatile

Question 23

Name two indenture provisions that can effect the maturity of bonds.

Answer 23

A call option and a nonrefunding provision

Question 24

What is the purpose of bond ratings?

Answer 24

To gauge default risk of the bond