Topic 7: Fixed Income Securities and Managing Bond Portfolios Flashcards

1
Q

Who are the different issuers of bonds?

A
  • U.S. treasury

- Corporate bonds

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2
Q

What type of bonds do U.S. treasury issue?

A
  • Notes (up to 10 years)

- Bonds (10 to 30 years)

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3
Q

What type of corporate bonds can be issued?

A
  • Callable bonds
    • Allowing issuers to repurchase bonds at a specified call price before maturity
  • Convertible bonds: Giving bondholders an option to exchange each bond for a specified number of shares of common stock of the firm
  • Puttable bonds: Allowing bondholders to
    extend or retire bonds
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4
Q

Realized compound yield equals to YTM when?

A
  • The reinvestment rate is YTM
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5
Q

Whats the difference between YTM and HPR?

A
  • YTM depends on coupon, current price and par value, and is a measure of the average rate of return if the investment in the bond is held to maturity
  • HPR is the rate of return over a particular investment period and depends on the market price of the bond at the end of the holding period
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6
Q

If short term interest rates are known with certainty then?

A
  • We can know the zero coupon bond prices, YTM (spot rates) and coupon prices.
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7
Q

What some features of liquidity preference?

A
  • Investors will demand a premium for the risk associated with long-term bonds
  • The yield curve has an upward bias built into the long-term rates because of the risk premium
  • Forward rates contain both a liquidity premium and expected future short-term rates
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8
Q

Features of a passive bond strategy?

A
  • Take market prices as fairly set
  • Control risk, balance risk and return
  • Immunization strategy to immunize interest rate risk
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9
Q

Features of an active strategy?

A
  • Trade on interest rate predictions

- Trade on market inefficiencies (mis-priced bonds)

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10
Q

What does an increase in a bonds YTM cause the price of the bond to do?

A
  • an increase in a bond’s
    yield to maturity results in a smaller price decline than
    a decrease in yield of equal magnitude
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11
Q

Are short or long term bonds more sensitive? Why?

A
  • Long-term bonds tend to be more price sensitive than
    short-term bonds, since the impact of the higher
    discount rate will be greater as that rate is applied to
    more-distant cash flows
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12
Q

What does higher coupon rate mean for interest rate sensitivity?

A
  • High coupon shortens the maturity of total cash flows–“effective maturity”. So higher coupon rates, lower interest rate sensitivity
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13
Q

What does higher yield mean for interest rate sensitivity?

A
  • A higher yield reduces PV of all of the bond’s payment, but more so for more distant payments, which leads a lower effective maturity and interest rate sensitivity
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14
Q

What is duration

A
  • A measure of the effective maturity of a bond
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15
Q

reasons duration is important?

A
  • It is a simple summary statistic of the effective average maturity of the portfolio
  • It turns out to be an essential tool in immunizing portfolios from interest rate risk
  • Duration is a measure of the interest rate sensitivity of a portfolio
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16
Q

Go over rules of Duration

A

Go over rules of duration

17
Q

What are the two types of interest rate risk fixed income investors face?

A
  • price risk and
  • reinvestment rate risk, (increases in interest rates cause capital losses but increase the rate at which reinvested income will grow)
18
Q

What is a substitution swap?

A
  • An exchange of one bond for a nearly identical
    substitute with essentially equal coupon, maturity,
    quality call features and so on
  • Example: a sale of a 20-year maturity, 9% coupon Ford bond callable after 5 years at $1050 with a YTM of 9.05%; a purchase of a 9% coupon GM bond with the same call provisions, time to maturity and credit rating that yields at 9.15%
19
Q

What is a inter-market swap?

A
  • When investors believe the yield spread between two sectors of the bond market is temporarily out of line
  • For example, if the yield spread between 10-year Treasury bonds and 10-year Baa-rated corporate bonds is now 3%, and the historical spread has been only 2%; an investor will consider buying corporates and selling Treasury bonds
20
Q

What is a rate anticipation swap?

A
  • If investors believe interest rate will fall, they
    will buy bonds of longer duration
  • If investors believe interest rate will rise, they
    will buy bonds of shorter duration
21
Q

What is a pure yield pickup swap?

A
  • When yield curve is upward sloping, investors will buy longer-term bonds and sell shorter term bonds to earn an expected term premium in higher-yield bonds
22
Q

For passive management what is cash flow matching and dedication?

A
  • Manager selects either zero-coupon or coupon bonds that provide total cash flows in each period that match a series of obligations
23
Q

What is contingent Immunization?

A
  • A combination of active and passive management
  • The strategy involves active management with a floor rate of return
  • As long as the rate earned exceeds the floor, the
    portfolio is actively managed
  • Once the floor rate or trigger rate is reached, the
    portfolio is immunized