Topic 7: Fixed Income Securities and Managing Bond Portfolios Flashcards
Who are the different issuers of bonds?
- U.S. treasury
- Corporate bonds
What type of bonds do U.S. treasury issue?
- Notes (up to 10 years)
- Bonds (10 to 30 years)
What type of corporate bonds can be issued?
- 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
Realized compound yield equals to YTM when?
- The reinvestment rate is YTM
Whats the difference between YTM and HPR?
- 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
If short term interest rates are known with certainty then?
- We can know the zero coupon bond prices, YTM (spot rates) and coupon prices.
What some features of liquidity preference?
- 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
Features of a passive bond strategy?
- Take market prices as fairly set
- Control risk, balance risk and return
- Immunization strategy to immunize interest rate risk
Features of an active strategy?
- Trade on interest rate predictions
- Trade on market inefficiencies (mis-priced bonds)
What does an increase in a bonds YTM cause the price of the bond to do?
- an increase in a bond’s
yield to maturity results in a smaller price decline than
a decrease in yield of equal magnitude
Are short or long term bonds more sensitive? Why?
- 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
What does higher coupon rate mean for interest rate sensitivity?
- High coupon shortens the maturity of total cash flows–“effective maturity”. So higher coupon rates, lower interest rate sensitivity
What does higher yield mean for interest rate sensitivity?
- 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
What is duration
- A measure of the effective maturity of a bond
reasons duration is important?
- 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