Unit 13: Fixed Income Flashcards
Long-term debt duration
minimum of 5 years, but usually 20-30 years
Who are the 3 major issuers of fixed income?
- U.S. government
- Corporations
- State governments/municipalities
Par/face value is always
$1,000
Bond pricing for corporations and municipalites
quoted as a % of par
1/8 = $1.25 1/4 = $2.50
Bond pricing for government
- quoted in points
90. 8 = $902.50
.8 means 8/32
Each .1 represents 1/32 of $10 = ($0.3125)
Treasury Inflation Protection Securities (TIPS)
- Helps protect investors against purchasing power risk
- Issues with a fixed interest rate, but the principal amount is adjusted semiannually
- Interest payments and increases in principal are subject to federal tax only
- Real rate of return will always be the coupon
S&P’s investment grade ratings:
AAA, AA, A, BBB
Moody’s investment grade ratings:
Aaa, Aa, A, Baa
Key points about convertible securities:
- They give the owner the opportunity to participate in the company’s growth through the ability to acquire common stock
- The coupon rate will be lower than non-convertibles of the same quality. (If a question asks about choosing an investment for income, you don’t select the convertible security.)
- They offer the potential stability of a debt security with the upside potential of an equity security
- Convertible securities generally sell at a price somewhat above the parity price
Nominal Yield
coupon rate, a 5% coupon rate pays $50 per year (2 payments of $25)
Current yield
annual interest in dollars / current market price
Yield to Maturity/Basis
annual interest - (premium/years to maturity)
/
average price of the bond
YTM is also called:
the market-driven yield because it reflects the internal rate of return from the bond investment.
The longer the duration,
the greater the market price movement.
The duration of a zero-coupon bond will always:
equal its length to maturity.
The longer a bond’s maturity,
the longer the bond’s duration.
For coupon bonds, duration is always
less than the bond’s maturity.
The longer a bond’s duration,
the more its value will change for a 1% change in interest rates.
Convexity
the measurement of the curve that results when plotting a bond’s price movements in response to changes in interest rates
convexity follows a curve
Comparing two bonds, the one with the higher convexity will show:
a greater price increase when yields fall.
If we find two bonds with the same duration, the one with the higher convexity offers
greater interest rate risk protection.
Which of the following is the most useful in determining the price volatility of a bond to a significant change in interest rates?
Convexity
Discount Cash Flow
Estimate the value of a fixed-income security by looking at the future expected cash flow and discounting it to arrive at a present value.
The higher the discounted cash flow,
the more value the investment.
An analyst would use the discounted cash flow method in an attempt to find:
the fair value of a security
When doing cash flow analysis on a mortgage-backed pass-through security,
you would want to know the average maturities.
