The Bond Market Flashcards
What does the bond market consist of?
The bond market consist of long-term debt (fixed income) securities, plus a number of associated interest rates
and credit derivatives
BONDS CREATE …
YIELD CURVES
because if bond prices go up, yields go down
What are the different types of bonds that make up the bond market?
1) Treasury or Government Bonds (major and most liquid)
2) Agency Debt (support government related projects)
3) Corporate bonds (issued by companies)
4) MBS
5) Assed-Backed Securities
2 types of Treasury Bonds
1) Nominal Bonds: Regular bonds that pay a fixed interest (coupon) over time.
2) TIPS (Treasury Inflation-Protected Securities): Bonds that protect investors from inflation by adjusting the principal value with inflation.
2 types of corporate bonds
- Investment Grade Bonds: Issued by financially stable companies—they are safer but offer lower returns.
- High Yield (Junk) Bonds: Issued by companies with a higher risk of default—they offer higher returns to compensate for the risk.
What do we use to calculate the the interest payments (cash flows) and discount factors for various financial instruments like bonds, swaps, derivatives)
- Frequency :
1) S/A : semi annual, twice a year
2) Q: Quarterly, every 3 months
3) A: annual, once a year - Day-to-count conversions:
1) ACT/ACT: The most precise convention. It uses the actual number of days in the period and the actual number of days in the year (365 or 366 in a leap year).
2) 30/360: This convention assumes 30 days per month and 360 days in the year.
3) ACT/360: This convention uses the actual number of days in the period, but assumes there are 360 days in the year.
What are Treasury notes vs Treasury bonds?
Treasury notes: maturities of 2,3,5,7 and 10 years
Treasury Bonds: long term maturities of 20 and 30 years (they are coupon bearing)
Treasury prices are quoted in ——-
32nds of a point
In bond markets, a “point” is 1% of the face value.
What are TIPS?
Treasury inflation protected securities. They adjust the principal and face value based on changes in the Consumer Price Index.
US gov bonds that protect against inflation
Inflation → CPI goes up → TIPS principal increases.
Deflation → CPI goes down → TIPS principal decreases.
SO THE TIPS YIELD IS REAL YIELD AS IT IS ADJUSTED FOR INFLATION
How do we measure the market’s expectation of inflation over the bond’s life?
Breakeven = Nominal Yield - Real Yield
If inflation exceeds the breakeven rate, TIPS will perform better than regular Treasury bonds.
What is Federal Agency Debt?
bonds issued by US FEDERAL AGENCIES backed by the full faith and credit of the government
if a U.S. company issues a bond in Europe in euros, that’s a ——
Eurobond
Types of corporate bonds
- Senior Unsecured Bonds (Debentures) These bonds are not backed by collateral
- Secured Bonds – These are backed by specific collateral, such as real estate or company equipment.
- Subordinated Debentures – These are riskier because they rank lower in repayment priority if a company goes bankrupt. If the company defaults, subordinated bondholders only get paid after senior bondholders are repaid.
- Convertible bond, which gives the bondholder the option to convert the bond into shares of the company at a predetermined price. These bonds allow investors to benefit from rising stock prices while still earning interest like a regular bond.
what are covenants?
special feature that affects bond value
legal restrictions placed on the company to protect bondholders (for example, limiting the company’s ability to issue more debt)
What does it mean if a bond comes with a call option?
the company can repay the bond before maturity at a specified price, usually if interest rates fall.
What are Munis or Municipal Bonds? Types?
Bonds issued by local government
1) General obligation bonds, backed by the full faith and credit of the issuer
2) Revenue bonds, issued to fund specific public projects, and normally backed by the revenues of the project or its managing agency. Typical issuers are airports, hospitals and port and highway authorities
What are tax anticipation notes?
Short term munis
Local entities can also issue industrial development bonds (IDBs), what are they?
Special type of revenue bond that fund commencial projects operated by private companies
What formula do we use to compare tax-exempt bonds to taxable bonds?
to determine which is more profitable after taxes
Equivalent Taxable Yield
ETY= muni rate / (1-t)
*(in formula sheet)
t=tax rate NOT IN FORMULA SHEET
t = 1 - (muni rate / taxable rate)
After the 2008 financial crisis, most MBS issued by GSEs contain only conforming mortgages, meaning ….
Government Sponsored Enterprises (GSEs)
they must meet strict credit and underwriting standards and come from regulated financial institutions
2 TYPES OF MBS:
1) pass-through MBS: mortgage payments are collected and passed
through to investors
2) Collateralised Mortgage Obligations (CMOs): more complex than pass-thorugh as they have several tranches of credit quality (Like CDO but only mortgages)
MBS are a type of
ABS
asset backed securities
securities collateralized by an underlying pool of assets, normally assets that generate cash
flows from debt, such as student loans, car loans and/or leases, or credit card debt.
