Flashcards in Topic 7: Fixed Income Securities and Managing Bond Portfolios Deck (23)
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
Go over rules of Duration
Go over rules of duration
What are the two types of interest rate risk fixed income investors face?
- price risk and
- reinvestment rate risk, (increases in interest rates cause capital losses but increase the rate at which reinvested income will grow)
What is a substitution swap?
- 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%
What is a inter-market swap?
- 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
What is a rate anticipation swap?
- 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
What is a pure yield pickup swap?
- 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
For passive management what is cash flow matching and dedication?
- Manager selects either zero-coupon or coupon bonds that provide total cash flows in each period that match a series of obligations