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CFA Level I > Reading 42 > Flashcards

Reading 42 Flashcards

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CFA flashcards
1
Q

type of bond with contingency provision (embedded option)

A
  • callable bonds
  • putable bonds
  • convertible bonds
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2
Q

Callable bonds

A

give the issuer the right to redeem all or part of the bonds before maturity date

  • high yield & low price compensate the bondholder for the vale of the call option to the issuer
  • provide protection to the issuer in decline interest rate environment
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3
Q

contingency provision is?

A

clause in legal document that allows for some action if the event does occur

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4
Q

embedded option

A

various contingency provision found in the indenture

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5
Q

puttale bonds

A
  • put provision
  • provide right to the bonholder to sell the bond back to the issuer at a pre-determined price ona specified date
  • lower yield on these bonds compensate the issuer for the value of the put option
  • pre-specified selling price of putable bond provide benefit to the bondholder
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6
Q

conversion price

A

price per share - convertible bond can be converted into shares

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7
Q

conversion ratio

A

number of common shares that each bond can be converted into

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8
Q

conversion value

A

current share price x conversion ratio

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9
Q

convertible bonds advantage for investors?

A
  • can participate in equity upside
  • receive downside protection
  • price of convertible bond can’t fall below the price of the straight bond
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10
Q

convertible bond

A

hybride security with both debt and equity features (bondholder has a right to exchange the bond for specified number of shares in issuing company).

  • price of a convertible bond is higher than the price of the bond without this provision
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11
Q

convertible bond may futher include what ?

A

call provision

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12
Q

tax consideration

A
  • income portion of a bond investment
  • capital gain / loss if the price is likely to have changed compared with the purchased price
  • different tax rate for long term and short term capital gains in different countries
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13
Q

income portions of a bond investment

A
  • taxed at ordinary income tax rate
  • tax-exempt securities (municipal bonds, US TREASURY SECURITIES) is exempt from federal income tax and from the income tax of the state in which the bonds are issued.
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14
Q

principal repayment structures

A
  • bullet, amortization bond (full and partial)

- sinking fund arrangements

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15
Q

bullet bonds

A

entire principle payment happens at maturity

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16
Q

amortization bond

A

periodic payment of interest and repayment of principle

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17
Q

partial amortized bond

A

fixed period payment until maturity & a portion of the principal at maturity date

  • ballon payment
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18
Q

ballon payment

A

payment to retire the bonds outstanding principal at maturity

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19
Q

sinking funds

A

issuer plan to set aside funds over time to retire the bond

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20
Q

benefitsof sinking fund arrangement

A

formal plan to retire the debt

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21
Q

disadvantages of sinking fund arrangement

A
  • reinvestment risk

- issuer may have option to repurchase bonds at below market price

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22
Q

bermuda-style call

A

issuer has the right to call bonds on a species fate following the call protection period

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23
Q

coupon payment structure

A
  • floating rate
  • step up coupon bond
  • credit link
  • payment in kind
  • deferred coupon
  • index linked
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24
Q

deferred coupon bond

A
  • paid no coupon for the first few years & pays higher than normal coupon for the remainder of its life
  • common in project financing
  • priced at significant discount to par.
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25
Q

index-linked bond

A

coupon & or principal repayment are linked to a specific index.
example: inflation-linked bond

  • real interest rate= nominal interest rate - inflation
  • equity-linked notes
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26
Q

real interest rate formula

A

nominal interest rate - inflation

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27
Q

equity-linked notes

A

final payment is based on the return of an equity index.

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28
Q

coupon

A

interest payment that the bond issuer makes to the bondholders

  • usually, coupon is paid semi-annual for sovereign & corporate bond
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29
Q

credit-linked coupon bonds

A
  • coupon rate change when bonds credit rating change

- attractive to investors who are concerned about the future creditworthiness of the issuer

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30
Q

payment-in-kind coupon bond

A

coupon is paid in the form of additional amounts of the bonds issue rather than as a cash payment

  • favored when issuer future cash flow will be questionable
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31
Q

step-up coupon bond

A
  • fixed or floating couping which increase by specified margin at specified dates
  • provides some protection against rising interest rates.
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32
Q

floating rate note

A
  • coupon rate is linked to an external reference rate -LIBOR

little interest rate risk
additional features may include floor or cap

  • typical coupon rate
  • variable rate note
  • inverse floater
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33
Q

typical coupon rate

A

3M libor + … bps(spread)

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34
Q

variable rate note

A

spread is not fixed

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35
Q

inverse floater

A

inverse relationship to the reference rate

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36
Q

fixed income security

A

an instrument that allows gov, companies & other types of issuers to borrow money from investors

  • adding fixed securities to portfolio add diversification benefits
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37
Q

adding fixed income securities to a portfolio does what ?

A

add diversification

38
Q

maturity date

A

date when the issuer is obligated to redeem the bond by paying the outstanding principal.

39
Q

tenor

A

time remaining until maturity

40
Q

money market securities

A

maturities at insurance of 1 year or less

41
Q

capital market securities

A

fixed securities with maturity more than 1 yr

42
Q

3 important elements of bond investing

A
  • the bonds features
  • legal, regulatory & tax consideration
  • contingency provision
43
Q

par value

A

principal or par value amount that the issuer agrees to repay the bondholder on maturity date

44
Q

credit risk

A

risk of loss resulting from the issuer failing to make full & timely payment of interest/ principal

45
Q

major type of bond issuer are:

A
  • supranational organization (IFM, world bank)
  • quasi-gov bonds
  • corporate issuers
  • non-sovereign gov bonds (cities)
  • sovereign gov bonds (fed)
46
Q

current denomination

A
  • dual currency bonds

- currency option bonds

47
Q

dual currency bonds

A

pay interest in one currency & principal in another currency

48
Q

currency option bonds

A

single currency bond + foreign currency option

49
Q

coupon rate and frequency

A
  • coupon/ nominal rate
  • plain vanilla bond
  • floaters
  • zero coupon bonds
50
Q

zero coupon bonds

A

issued at discount to par & reddem at par

51
Q

floaters

A

bonds with floating rate coupon

52
Q

plain vanilla bond

A

fixed rate bond

53
Q

coupon/ nominal rate

A

interest rate that the issuer agrees to pay every year until maturity

54
Q

yield to maturity

A

internal rate of return on bonds expected cash flow

  • lower interest rate scenario anticipation, lower yield to maturity demand
55
Q

current or running yield

A

bonds annual coupon / bonds price

56
Q

bond indentures

A
  • trust deed (indenture)
  • collateral
  • credit enhancement
  • covenants
57
Q

indenture (trust deed)

A

legal contract that describe:

  • bond form
  • issuer obligation
  • bondholder rights
58
Q

collateral

A

assets or financial guaranteed above & beyond the issuer promise to pay

59
Q

credit enhancement

A

provision to reduce the credit risk of the bond issue

60
Q

covenants

A

clauses that define bondholders right and an issuer’s actions

61
Q

bonds issuer is legally obligated to make what kind of payment?

A

contractual payments

62
Q

source of repayment proceeds

A
  • supernational organization
  • sovereign bonds
  • non-sovereign gov debt (bond)
  • corporate bonds
  • securitization
63
Q

securitization

A

cash flow generated by one or more underlying financial assets

64
Q

corporate bonds

A

issuer ability to generate cash flow from operations

65
Q

non-soveriegn gov debt (bond)

A
  • tax
  • special tax or fees
  • cash flow of project (financed with bond issue)
66
Q

supranational organization

A

either the repayment or previous loans or the paid-in-capital from its members

67
Q

sovereign bonds

A

tax revenue & print money is the major source of repayment

68
Q

credit enhancement

A
  • internal credit enhancement (subordination)
  • > junior tranche
  • > excess spread
  • external credit enhancement
  • > surety bond
  • > letter of credit
69
Q

credit enhancement

A

variety of provision that can be used to decrease the credit risk of a bond issue

70
Q

surety bond

A

issued by a rated & regulated insurance company

71
Q

letter of credit

A

provide by a financial institution

-> less common form

72
Q

internal credi enhancement (subordination)

A

ordering of claim priorities for ownership or interest in an asset

73
Q

junior tranche

A

function as credit protection for senior tranche

74
Q

excess spread

A

difference between cash flows received from the assets used to secure issue & the interest paid to investors

75
Q

euro bonds

A

bond issued & traded on euro bond market

  • bearer bond
  • registered bond
76
Q

bearer bonds

A

trustee does not keeep records of bonds ownerships

77
Q

registered bonds

A

ownership is recorded by either name or serial number

78
Q

national bond market

A

bond that are issued & traded in a specific country

79
Q

legal & regulatory concerning fixed income?

A

fixed income securities are subject to legal and regulatory requirement

80
Q

seniority ranking

A
  • secured bonds
  • debentures
  • unsecured bonds
81
Q

secured bonds

A

backed by asset or financial guarantees pledge to ensure debt repayment in case of default

82
Q

debenture

A

types of bonds that can be unsecured

83
Q

unsecured bonds

A

no collateral bond

84
Q

covenants

A
  • bonds covenants
  • affirmative covenants
  • negative covenants
85
Q

bond covenants

A

legally enforceable rules that borrowers & lenders agree on at the time of a new bond issue

86
Q

affirmative covenants

A

what issuer are required to do (admin nature)

87
Q

negative covenants

A

what issuer are prohibited from doing (costly & do materially constrain the issuer potential business decision)

example: restriction on debt, negative pledges. restriction on prior claims restriction on investments

88
Q

types of collateral backing

A
  • collateral trust bonds
  • equipments certificates
  • mortgage backed securities
  • covered bonds
89
Q

collateral trust bonds

A

secured by securities such as shares other bonds or financial assets

90
Q

equipment trust certificates

A

bonds secured by specific types of equipments or physical assets

91
Q

mortgage-backed securities

A

debt obligations that represent claims to the cash flow from pools of mortgage loans

92
Q

covered bonds

A

debt backed by a segregated pool of asset called cover pool.

CFA Level I (11 decks)

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