Week 6 - Bond Markets Flashcards
YTM and bond price
They move in opposite directions
Interest rate and bond price
Inversely related
Factors affecting bond price
- Higher coupon payment leads to higher price
- Higher par value will have a higher price
- higher years to maturity has a higher price
Secondary capital market factors
- credit rating
- liquidity
- time for next payment of bonds
Market risk
Risk of unexpected changes in prices or rates
Credit risk
Risk of default or reduction in value
Default risk
Possibility that a counter party in financial contract will not fulfil a contractual commitment
Credit rating
Evaluation of credit worthiness of a debtor
Ratings agencies
Assess the credit risk of specific debt securities and borrowing entities
Rating analysis
- Business Risk: evaluation of strength/weakness of operations of the entity
- Financial Risk: evaluation of financial flexibility
Risks and macro fundamentals
Ordering of risks is broadly consistent with macroeconomic fundamentals
Factors correlated with high earnings
- High per capita income
- Lower inflation and lower external debt
Yield curve
Shows interest rate associated with different contract lengths for a particular debt instrument
Gradient of yield curve
Gives an indication of forthcoming interest rate changes
Term structure of interest rates
Indicated that the slope of the yield curve provides general info about market prediction of future path
Shape of a yield curve
Shows what investors believe will happen in fixed income market in the future
Normal yield curve
Upward sloping depicting higher interest rates for longer held maturities
Yield curve steepens
-Spread b/w long and short term interest rates widens
- indicates positive economic sentiment
Flat yield curve
- illustrates very little difference b/w shirt and long term interest rates widens
- signals uncertainty in the market from investor POV
Inverted yield curve
-downward sloping and shows longer term maturities yielding lower returns
- negative economic sentiment
Change in IR
Larger effects on long term bonds than short term bonds
