Fixed Income Securities Test 1 (Answered) Complete Solution

Fixed Income Securities Test 1 (Answered) Complete Solution Fixed income securities can also be referred to as? debt securities and bonds a fixed income security is a __________ obligation debt What is the largest subset of financial markets? global fixed income markets global fixed income markets is the largest by what criteria? - number of shares - market capitalization In 2010 global fixed income markets were ____ times larger than global equity markets? 3 In fixed income markets, what are the goals of issuers and investors? -debt issuers have financing needs that must be met -debt investors have return goals Sectors of the US Bond Market - Treasury Sector - Agency Sector - Municipal Sector - Corporate Sector - Asset-backed sector - Mortgage Sector Treasury Sector securities issued by the US government Agency Sector securities issued by federally related institutions and government-sponsored enterprises Municipal Sector Securities issued by state and local government bonds Corporate Sector securities issued in the US by US corporations and foreign corporations Asset-backed sector securities backed by a pool of assets Mortgage sector securities backed by mortgage loans What are the types of bond investors? - retail investors -institutional investors Bond Investors Retail Investors an example is mutual funds of bonds. It is a pooled investment vehicle. The advantages are: - better diversification - better liquidity - professional management Institutional Investors for bonds What are some examples? - Institutional portfolios - funds What are the important features of a bond? - type of issuer - term to maturity - principal and coupon rate - amortization feature - embedded options - bond issuer description What are the types of issuers for bonds? - the federal government and its agencies - municipal governments - corporations (both domestic and foreign) define term to maturity? number of years by which the issuer has agreed to abide by the terms of the debt obligation There may be terms that allow a bond issuer or bondholder to alter a? alter a bond's term to maturity Principal Value amount the issuer agrees to repay the bondholder at the maturity date Coupon rate - this is the nominal rate of interest for the bond - this is the interest rate the issuer agrees to pay each year the coupon rate is expressed as? a percentage of the instruments par value the annual monetary amount of interest is called the instrument's? coupon payment zero-coupon bond interest is paid at the maturity with the exact amount being the difference between the principal and the price paid for the bond Floating Rate Bonds the coupon rate for these bonds resets periodically based on the coupon reset formula coupon reset formula floating coupon rate = reference rate + quoted margin Floating Rate Bonds Different Types of Reference Rate - LIBOR - Linkers - Inverse-floating rate bonds LIBOR London Interbank Offered Rate - Rate at which the highest credit banks borrow from each other in the London interbank market. Linkers bonds whose interest rate is tied to the rate of inflation Inverse Floating Rate Bonds coupon interest rate bonds moves in the opposite direction from the change in interest rates Amortization Feature Bullet bonds entire principal repayment is made at maturity Amortization Feature amortizing bonds principal is repaid over the life of the bond amortization schedule there is a schedule of principal repayments weighted average life if computed most commonly for mortgage backed and asset backed securities Types of Embedded Options - call provision - put provision - convertible bond - exchangeable bond call provision issuer has the right to retire the debt prior to maturity (this can be done fully or partially) put provision bondholder has the right to sell the issue back to the issuer at par value on designated dates convertible bonds bondholder has the right to exchange the bond for shares of common stock exchangeable bond bondholder can exchange the issue for a specified number of common stock shares of a corporation from the issuer of the bond Describing a bond issue Most securities are identified by a ________ number CUISP first 6 characters of CUSIP number identify the? issuer the last character of the CUSIP allows for accuracy checking CUISP international numbering system identifies foreign securities and includes _ characters 12 Types of Bond Investment Risk - interest rate risk (can also be thought of as price risk) - reinvestment risk - call risk - credit risk - inflation risk - exchange rate risk - liquidity risk - volatility risk - risk risk Interest rate risk risk of having to sell the bond prior to maturity at a loss (the major risk faced by an investor in the bond market) reinvestment risk the risk that interim cash flows can only be invested at a lower rate interest rate risk and __________ risk have offsetting effects? interest rate risk and reinvestment risk have offsetting effects credit risk is? the risk that the bond issuer will not be able to pay his debts credit spread = credit spread = risky bond yield - risk free bond yield inflation risk risk associated with the variation in purchasing power of the cash flows from the security (think if inflation rate exceeds coupon rate you are losing purchasing power) Except for floating rate bonds, investors are always exposed to? inflation risk (because the payment is fixed for the life of the bond) Exchange Rate Risk the unexpected change in one currency compared to another volatility risk risk that a change in volatility will adversely affect the price of a bond with an embedded option risk risk risk of not knowing the risk of the security (occurs mostly with very complicated securities that are hard to understand) What is the cash flow of a seven-year bond that pays no coupon interest and has a par value of $10,000? 10,000 (it is a zero coupon bond so it's only cashflow is the principal) 3 reasons why the maturity of a bond is important? 1. Maturity gives the time period over which the bondholder can expect to receive payments 2. Yield of the bond is dependent on the maturity 3. Volatility of a bond's price is dependent on its maturity with all other factors constant, the longer the maturity of a bond, the greater the price volatility resulting from a change in market yields. with all other factors constant, the longer the maturity of a bond, the greater the price volatility resulting from a change in market yields. How much is a basis point? .0001 or .01% Suppose that on a coupon reset date that 1-month LIBOR is 2.8% and quoted margin is 220 basis points. What will the coupon rate be for the period? coupon reset formula: Floating rate = reference rate + quoted margin floating rate = 2.8% + 2.20% = 5% What is a deferred coupon bond? coupon bonds that let the issuer delay payment in earlier years What are the three types of deferred coupon bonds (1) deferred-interest bonds (2) step-up bonds (3) payment-in-kind bonds. deferred interest bonds A bond whereby the issuer is allowed to defer coupon interest for a specified period of time. step up bonds A step-up bond is a bond that pays an initial coupon rate for the first period, and then a higher coupon rate for the following periods. payment-in-kind bonds A payment-in-kind bond is a form of mezzanine debt that lessens the financial burden of making cash coupon payments to investors. No cash interest payment is made until the bond is redeemed or the total principal is repaid at maturity. On the dates when the coupon payments are due, the accrued interest on PIK debt is paid through the additional issuance of bonds, notes, or preferred stock. Why is the maturity of an amortizing security not a useful measure? For an amortized security, the repayment of the principal is made through multiple payments over its maturity and not just at the end of its term to maturity. Thus, the maturity is not a useful measure in terms of identifying when the principal is repaid. What is meant by JPY LIBORBBA? JPY LIBORBBA refers to the Japanese yen LIBOR interest rate. This rate is the average interbank interest rate at which a large number of banks on the London money market are prepared to lend one another is unsecured funds denominated in Japanese yen. How do market participants gauge the default risk of a bond issue?