lesson 2:debt securities:all 3 videos
what is the type of risk rated by Moody's, Standard and Poor and Fitch?
Default or Credit risk
what are municipal securities?
issuances by state, cities, counties, and their agencies to support their day-to-day obligations and finance many projects for the pubic good
what is a high yield bond?
it is also referred to as a junk bond. it is a non investment-grade bond that has a higher chance of default
what is yield to call?
it is the same as yield to maturity, but it assumes that the bond is called. -the rate of return on a bond (yield) that accounts for the difference between purchase price and the amount of proceeds received on the earliest call date
what does credit rating do?
it measures the risk of default by an issuer
when will there be a long duration? when will there be a short duration?
long duration: low coupon and long maturity short duration: high coupon and short maturity
of long term and short term bonds, which generally pays a higher interest amount?
long term bonds
what uses. 360 day year in the calculation of accrued interest
municipal and corporate bonds
what is another name for the coupon yield?
nominal
bonds are subject to amortization only if they are:
purchased at a premium. -for tax purposes, the premium must be amortized on a straight-line basis annual
how do you avoid accretion?
put these instruments into tax-deferred accounts (accounts you dont have to pay taxes every year), such as retirement accounts, college and education savings account, etc.
what is a bond that can be sold at face value back to the issuer prior to maturity at pre-determined times called
puttable bond
a bond is considered investment grade is it is:
rated In the top credit rating tiers by leading bond rating services. -investment grade bonds command the greater market demand and have good liquidity
what is the process of calling bonds when interest rates have fallen?
refunding
risk that proceeds from a callable bond cannot be invested as favorable
reinvestment risk
what is paid back?
return par value of maturity
if interest rates rise, the current yield of a bond will:
rise. this is because current yield = annual interest/bond market price. if interest rates rices, bond market prices will fall (to make them more appealing)
what is the frequecy of interest payments to bondholders
semiannual
how often are bonds paid back?
semiannual interest (coupons)
of long term and short term bonds, which generally has a lower price volatility?
short term bonds
what is a special account in which issuer funds are set aside in advance of a call
sinking fund
when interest rates decline, the nominal yield of a bond will:
stay the same. nominal yield is annual coupons paid/par value. neither input changes over the life of the bond
the tax treatment of accrued interest in a taxable bond is:
taxable as ordinary income to the bond seller, in the amount received by the buyer. it does not impact the bond's tax cost basis
what is accretion
the assumed or phantom income that the government takes u to have earned each year
who does the bond belong to on settlement?
the buyer
what is the coupon?
the coupon is the rate that you receive from lending the money and that is a percentage of the par (which is by default $1000) -the annual rate paid on the face amount -quoted as a percentage of a par -typically paid out semiannually
what is accrued interest?
the earned but unreceived interest owed to a bondholder.
what does it mean when a bond is puttable?
the investor can demand early repayment of principle -lower coupon for investor
do short or long durations have more of a interest rate risk?
the longer the duration, the higher the interest rate risk.
what is yield to worst (YTW)
the lower of yield to call or yield to maturity and because it conveys the worst return an investor might receive, it must be printed on the trade confirmation -for a discount bond, the YTW is the yield to maturity and for a premium bond it is the earliest yield to call
question: -coupon rate of bond is 3% -prevailing market rate is 2% what is the market price?
the market price is premium because coupon is higher, higher rate of return.
what is duration?
the measure in years of how much a bonds price is likely to change when rates move.
the amount of accrued interest that a bond buyer will pay to the seller is determined by:
the number of dats the bond has been held by the seller, divided by the total number of days in the coupon period. this fraction is multiplied by the coupon payment.
what is yield to maturity?
the overall return if bond is held until maturity. -the rate of return on a bond (yield) that accounts for the difference between purchase price and the amount of proceeds received at maturity -typically the most widely quoted yield for bonds
what is refunding
the process by which an issuer refinances, selling cheaper bonds at a lower rate to replace the more expensive, callable bonds before maturity.
what is refinancing
the process of replacing a higher interest rate loan with a new loan at a lower rate of interest
what is credit risk
the risk of default (i.e: an issuer cannot make interest or principle payments) -rating agencies help investors evaluate credit risk credit risk is a big liquidity factor
what is reinvestment risk
the risk that as interest rates decrease, the fixed coupon payments that an investor receives will be put back into the market at a lower return 0because zero-coupon bonds do not pay interest, they do not face reinvestment risk
what is interest rate risk?
the risk that the price of a bond will change due to changes in prevailing interest rates
how can investors avoid getting a bond called?
they can buy bonds that carry a call-protection period, where the issuer promises (not legally allowed to) call the bond. ex: i have 20 year bond with a 10 year call-protection period.
when are bonds more likely to be called by the issuer?
when interest rates are low
can the bondholder sell the bond after 2 years, and if so, at what price?
yes-at market price (whatever the buyer is willing to pay for the bond at that time). now, every 6 months the issuer is going to make the interest payment to the new owner.
what are serial bonds
bonds maturing at different intervals, with a portion of the issue maturing each year
accrued interest is paid by:
buyers of bonds to sellers of bonds
what is the amount above par that an issuer may pay to call bonds
call premium
what is the specific period from date of issue when a bond cannot be called?
call protection period
which bonds are most volatile to interest rate risks? _____ coupon _____ maturity
1. low coupon 2. long maturity (long duration)
An investor owns a 10% bond purchased at 99 that is callable at 102. If the bond is called away by the issuer on the coupon payment date, how much money does the investor receive?
$1,070 -if the bond is called we get 1020 which is the par + call premium and then you add $50 because that is your last $50 coupon.
what is the value of 1 bond point?
$10 I htink its because : (.01 X 10000 = 10)
a bond issue is purchased at a price of $1,250 and will mature in 10 years for par value of $1000. the amount amortized each year is:
$25. amortization means the tax cost basis of the bond is adjusted downward toward par on a straight line basis. (250/10 years = 25)
an investor buys a 10 year, $1000 par value bond with a 6% coupon. how much interest should an investor expect to receive in each payment?
$30. -why?: 6% of 1000 is 60 dollars per year. it is paid semi-annually so that makes it 30 dollars per every 6 months
a bond has a par value of $1000. on feb 1, when the market value is $1,100, it is called at a price of $1,060. the amount of the call premium is:
$60 per bond. the call premium is the amount in excess of par that issuer agrees to pay if the bond is called prior to maturity
an investor buys a 10 year, $1000 par value bond with a 6% coupon. how much interest will the investor receive if the bond is held until maturity?
$600
what is call risk?
-The risk that a bond is redeemed before its maturity. Once called, interest payments stop. Bonds are called by the issuer when interest rates are low.
how do interest rates affect bond prices?
-as interest rates rise, bond prices fall -as interest rates fall, bond prices will rise why?: because if interest rates are low, then market rates are low, so in order to make our offering more appealing, we increase our interest rates. if interest rates are high, then demand is high so prices are high, so we decrease our price to make our offering more appealing.
What features make a bond more sensitive to interest rate risk?
1. the coupon(percentage) 2. the maturity
what are benefits to the issuer in regards to fixed-income features?
-if it is callable. (higher coupon for investor) -issuer can "call" or redeem the bond at a set price (typically par) before maturity. -bonds cannot be called during a call protection period, which can provide safety for investors
when does interest accrue?
-interest accrues to the seller up to, but excluding, settlement -corp and municipal bonds accrue using a 30-dau month, and 360 day years (T+2) -gov't bonds accrue using actual days in each month and year (T+1) -the buyer pays the seller for any earned, but unreceived interest (the accrued)
life of a bond explained -ex: 5-year 9% coupon bond
-issued at par ($1,000) -$45 interest payment every 6 months -check is received at maturity for $1,045: after 5 years, redeemed at par ($1,000) + final semiannual coupon ($45)
when does the payment transfer to buyer?
-on trade day, the buyer pays the seller for the interest accrued prior to settlement -on T+1, the seller still owns the bond and gets the interest -on T+2, the bond becomes the buyers and the buyer is entitles to the interest -interest will acrue to the seller of a bond up to but excluding the settlement date you aheb to be able to define and describe to the regulators that when clients sell bonds, they may receive some interests that htey have earned but not yet received from the issuer or the buyer might have to pay the seller the seller's accrued interest.
what is the equivalent of 100 basis points?
1%
what is the current yield for the following bond quotes? (for 8% bond) A. 90 B. 100 C. 132
1. 90: $80/$900 = 8.9% 2. 100: $80/$1000 = 8.0% 3. 132: $80/$13200 = 6.1%
A 10% march and September corporate bond is traded on monday, June 2nd. how many days of interested accrued? 2. is the interest taxed for the recipient? 3. a bond that trades with no accrued is said to be..
1. 94 days worth of interest 2. seller of bond gets proceeds of bond plus accrued interest of buyer. this is taxable and is taxed as ordinary income bc its interest. 3. trade flat (ex: zero-coupon bond)
give examples of possible borrowers for bonds
1. corporations 2. governments 3. municipalities
give some examples of investors for bonds
1. individuals 2. institutions
what happens when bondholders sell their bond?
1. they sell it at market price (whatever the buyer is willing to pay) 2. every 6 months the new owner receives the interest payments 3. at maturity, the new owner receives the $1000(par value) plus the the final semi-annual coupon compensating the investor for lending the money over the past 6 months
An investor buys a 20-year, $1,000 par value zero-coupon bond for $350. 1. what is annual interest rate received each year? 2. to entice buyers, how are these bonds priced at issuance? 3. what does the owner receive at maturity? 4. what profit is earned if held until maturity? 5. what is the investment objective for zeros? 6. what risks are associated with zeros?
1. zero 2. priced lower than market 3. 1000 4. 650 (1000-350) 5.long term return 6. -zero coupons are lowest possible coupon, meaning higher interest rate risk (volatility) -phantom income tax on annual accretion
what is the amount that a bondholder receives at maturity of an ABC 9% bond?
1045 par = 1000 semiannual interest = 45 1000 + 45 = 1045
what is the difference in basis points between 6.20% and 6.50%
30 basis points
a bond has a par value of $1,000 and is trading at $1,200. it pays a $30 semiannual coupon. its current yield is:
5% (5% X 1200 = 60/2 = 30)
a bond has a par value of $1000 and pays annual coupons of $65. its nominal yield is :
6.5% -nominal yield is calculated as annual coupons/par value
what does it mean when a bond is called?
A call is when the issuer repays the principle early. this is a feature where, if a bond is callable, you could get your money sooner which could be good or bad.
Which of the following bonds typically has the least price volatility? convertible corporate bond or corporate floating bond?
A corporate floating rate bond. Bonds that have a floating interest rate, also known as variable rate bonds, have little price change. The interest rate, not the price, adjusts to reflect current market conditions. Corporate zero bonds are quite volatile, as are bonds that have longer maturities.
what is the price of a bond and what are the YTM if: A. quote is 112 B. quote is 105 C. quote is 100 D. quote is 97 E. quote is 83
A. 112% X 1000 = 1120 YTM: lower than coupon B. 105% X 1000 = 1050 YTM: lower than coupon C. 100% X 1000 = 1000 YTM: same as coupon D. 97% X 1000 = 970 YTM: higher than coupon E. 83% X 1000 = 830 YTM: higher than coupon
Which of the following is characteristic of bearer bonds?
Bearer bonds have interest coupons attached. The interest is payable to the individual who presents the appropriate coupon.
As compared to short term bonds, bonds with a longer time until maturity usually I. have higher interest rates II. have lower interest rates III. are more marketable IV. are less marketable
I and IV Longer term bonds are more risky than short term bonds. Because of this risk, they are less marketable, and must pay a higher interest rate to attract purchasers.
A 10-year municipal bond, callable in 5 years, is trading at 97 7/8. Rank the following yields from lowest to highest. I. Current yield II. Nominal yield III. Yield to call IV. Yield to maturity
II, I, IV, III When a bond is trading at a discount, nominal yield is lowest, then current yield, YTM and finally YTC.
Accrued interest is calculated from the ______ to the _______
Last interest payment date up to but not including the settlement date -This represents the amount of money the buyer of the bond must pay to the seller of the bond when the bond changes hands
does accrued interest affect the bond's cost basis?
NO.
what is the regular way settlement for treasuries (hint: different than rest)
T + 1 days
what is the term for the relationship between interest rates and bonds?
THEY ARE INVERTED
The par value of a bond is lower than the market value of the bond. -the YTM of the bond is (higher or lower) than the YTC
The YTM of the bond is higher than the YTC This bond is currently trading at a premium, since the market value of the bond is greater than $1,000. As such, the highest yield on this bond will be its nominal yield, followed by the current yield, yield to maturity (YTM), and finally yield to call (YTC), in descending order.
what is inflationary risk? what does it also apply to?
The risk that an investment's returns provide reduced purchasing power because the return is fixed (a coupon), but costs are rising. Also applies to preferred stock.
what are reinvestment trade risks?
The risk that an investor is unable to reinvest capital at a previously earned rate of return. The investable capital could be interest payments or the return of principal from a called bond.
what uses a 365-day year in the calculation of accrued interest
U.S gov't bonds and notes
what are the type of bond issue that are not callable?
U.S government bonds (treasury bonds)
what is the type of U.S. treasury security with the least exposure to interest rate risk
U.S treasury bills (T-bills) . -very short maturities-T-bills have less exposure to interest rate risk than longer-term treasury notes or bonds
The process by which an issuer calls bonds with a high coupon and reissues new bonds with a lower coupon is referred to as
When interest rates have fallen, issuers are likely to call outstanding bonds with high coupon rates and issue new bonds at the lower current rate. This process is called refunding or refinancing.
what is investment grade
a bond rating that reflects a lower chance of default
what does it mean to trade flat
a bond that does not pay accrued interest, such as a zero or a bond currently in default
what is the most influential factor in determining the pricing of a bond
a change in interest rates
what is a bond?
a loan from an investor to an issuer -a debt security
what is a creditor?
a person or company who is owed money. -ex: purchaser of a bond
what is a term bond
a type of bond issuance in which all bonds mature at once. sometimes the bonds are referred to as dollar bonds because they re typically quoted based on their price, expressed as a percentage of par
sinking fund
an account in which a bond issuer regularly sets aside money (typically in an escrow account_ for the redemption of bonds before maturity. this makes the issuance safe and more marketable
which types of investors might be interested in zero-coupon bonds
an investor that is saving up for a future event because the investor can put up less money up front, while receiving the full amount of principle at maturity
what is a coupon yield (AKA nominal yield)
annual interest, established at issuance -percentage of par -DOES NOT CHANGE
what is the formula for computing current yield
annual interest/current market price
how are bond prices quoted
as a percentage of par
what are bond quotes?
bond quotes state the price of a bond as a percentage of its par value
what type of risk applies?: New bonds, similar to those in a client's portfolio, are being issued with lower coupon
call risk and reinvestment risk because the issuer who is paying you semi-annual coupons might call in those expensive bonds, repay those lenders, and borrow more cheaply in the market. if you are getting those coupons, even if the bond isnt callable, you are getting those coupons, and you go bac to your broker and say where can i redeploy these new interest payments the broker saysa the interest rates on those kinds of securities are alittle lower b/c prevailing rates hve dropped
which of the following debt instruments would appreciate the most in a time of falling interest rates? A. 10 year, zero coupon bond B. 10 year 3% coupon bond C. 30 year zero coupon bond D. 30 year 3% coupon bond
choice c: 30 year zero coupon bond because longest duration and smaller coupon
what is the formula for "current yield"
coupon yield divided by market price: annual interest/current market price
Standard and Poor's, Mood's, and Fitch are examples of
credit rating agencies
what type of risk applies?: An issuer faces business difficulty and is downgraded.
credit risk. sister risk associated with low credit rating is liquidity risk
of YTC, YTM and CY, the yield that is the highest when a bond is trading at a premium and is callable:
current yield (CY)
what is the date on which interest on new municipal bonds being to accrue?
dated date
If a 9% bond is sold two years later when prevailing interest rates are 12%, the bond will sell at a:
discount
an issuer with outstanding bonds that have a 5% coupon issues similar new bonds with a 6% coupon. the outstanding bond will trade at a:
discount
A bond that is trading flat
does not include accrued interest in its trading price -In certain bond markets accrued interest is included in the trading price, and in other markets it is added on after trading. A bond trading with accrued interest is trading at its "full" price; a bond trading without accrued interest is trading "flat." Examples of bonds that trade flat include zero coupon bonds and bonds in default.
what kinds of bonds have high liquidity? which bonds have low?
high: good credit low: bad credit
what type of risk applies?: A client is concerned that the income his portfolio produces is insufficient to maintain the standard of living he is accustomed to.
inflation or purchasing power risk because if you have a fixed income protfolio, the amount of income you generate is fixed every year. but over time the cost of goods and services is increasing (inflation).
what type of risk applies?: New bonds, similar to the ones in a client's portfolio, are being issued with higher coupons.
interest rate risk. price of your bond will go down if interest rate goes up
what is the main risk of investing in long-term US treasury bonds
interest rate risk. treasury prices will decline if rates rse. however, there is very little credit risk in the U.S treasuries because of their high quality
what is the relationship between bond prices and bond yields
inverse
what does it mean when a bond is convertible?
investor can convert bond into a fixed number of common shares. -lower coupon for investor allows for investor to convert the bond into shares of common stock. why would an investor offer this? it allows them to do a bond at a lower coupon.
