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FIXED-INCOME SECURITIES: DEFINING ELEMENTS (CFA)
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Don't count this. By issuing a bond, someone borrows money from an investor. Who in return are paid interest on money they loaned (coupon payments)
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The annual amount of interest payments made is called the?
Coupon
A bond's coupon is determined by multiplying its ____________ and ____________.
1. Coupon Rate
2. Par (Face) Value
The coupon payments of bonds may be paid in what frequency?
1. Annually
2. Semiannually
3. Quarterly
4. Monthly
The ____________ of a bond is the amount the issuer agrees to repay the bondholders on the maturity date. What are eight other names for (1)?
1. Par (Face) Value
2. Principal Amount
Principal Value
Principal
Par
Face Value
Nominal Value
Redemption Value
Maturity Value
Note: Bonds can have ANY par value
In practice, bond prices are quoted as a percentage of their par value. For example, assume that a bond's par value is $1,000. A quote of 95 means that the bond price is $950 (95% × $1,000). When the bond is priced at 100% of par, the bond is said to be trading at par. If the bond's price is below 100% of par, such as in the previous example, the bond is trading at a discount. Alternatively, if the bond's price is above 100% of par, the bond is trading at a premium.
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Coupon payments may be made annually, such as those for German government bonds or Bunds. Many bonds, such as government and corporate bonds issued in the United States or government gilts issued in the United Kingdom, pay interest semi-annually. Some bonds make quarterly or monthly interest payments. The acronyms QUIBS (quarterly interest bonds) and QUIDS (quarterly income debt securities) are used by Morgan Stanley and Goldman Sachs, respectively, for bonds that make quarterly interest payments. Many mortgage-backed securities (MBS), which are ABS backed by residential or commercial mortgages, pay interest monthly to match the cash flows of the mortgages backing these MBS. If a bond has a coupon rate of 6% and a par value of $1,000, the periodic interest payments will be $60 if coupon payments are made annually, $30 if they are made semi-annually, $15 if they are made quarterly, and $5 if they are made monthly.
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A conventional bond (or ____________) pays a ____________ rate of interest.
1. Plain Vanilla Bond
2. Fixed
A ____________ (or ____________) are bonds that pay a variable (or _____________) rate of interest
1. Floating-Rate Note (FRN)
2. Floaters
3. Floating
The coupon rate of an FRN includes two components:
1. Reference Rate
2. Spread (also called Margin)
When figuring out the coupon rate of an FRN, the spread (or Margin) is typically ____________ and expressed in?
1. Constant
2. Basis Points (bps)
A Basis Point is equal to ____________%, so there are 100 Basis Points in?
1. 0.01%
2. 1%
The Spread (or Margin) is set when? It is based on the issuer's?
1. The bond is issued
2. Creditworthiness at issuance (higher credit quality, lower the spread)
The reference rate ____________ periodically. So what does this mean?
1. Resets
2. As the reference rate changes, the coupon rate and coupon payment change accordingly
A widely used reference rate for FRNs is the?
London Interbank Offered Rate (LIBOR)
LIBOR is a collective name for a set of rates covering different currencies for different maturities ranging from ____________ to ____________.
1. Overnight
2. One Year
For example, assume that the coupon rate of a FRN that makes semi-annual interest payments in June and December is expressed as the six-month Libor + 150 bps. Suppose that in December 20X0, the six-month Libor is 3.25%. The interest rate that will apply to the payment due in June 20X1 will be 4.75% (3.25% + 1.50%). Now suppose that in June 20X1, the six-month Libor has decreased to 3.15%. The interest rate that will apply to the payment due in December 20X1 will decrease to 4.65% (3.15% + 1.50%).
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All bonds, whether they pay a fixed or floating rate of interest, make periodic coupon payments EXCEPT? Instead, they are issued at a ____________ to Par (Face) Value and redeemed at ____________. They are sometimes also referred to as?
1. Zero-Coupon Bonds
2. Discount
3. Par
4. Pure Discount Bonds
When using a zero-coupon bond, the interest earned is implied and equal to the difference between?
Par Value and Purchase Price
For example, if the par value is $1,000 and the purchase price is $950, the implied interest is $50.
____________ bonds make coupon payments in one currency and pay the par (face) value at maturity in another currency.
Dual Currency
The Coupon Rate (or ____________) of a bond is the interest rate that the issuer agrees to pay each year until the?
1. Nominal Rate
2. Maturity Date
A large number of bonds issued are made in what currency? Why is this?
1. US Dollar or Euro
2. More liquid and less volatile currency is more attractive. For this reason, a developing country may issue a bond to be paid in one of these currencies
A bond issuer can reduce currency risk by issuing a bond in what type of currency? Why?
1. Foreign
2. If they are expecting to receive cash flow in the foreign currency, now the interest payments and principal payments can act as a natural hedge.
____________ bonds can be viewed as a combination of a single-currency bond with a foreign currency option.
Currency Option
In a Currency Option Bond:
The bondholders have the right to choose the currency in which they want to receive interest payments and principal payments. Bondholders can select on of two currencies for each payment.
The Current Yield (or ____________) is equal to the bond's? Expressed as a(n)?
1. Running Yield
2. Annual Coupon / Bond's Price
3. Percentage
The Current Yield is a measure of ____________ that is analogous to the ____________ for a common share.
1. Income
2. Dividend Yield
Example: What is the Current Yield for a bond that has a coupon rate of 6%, a par value of $1,000, and a price of $1,010?
1. 5.94%
6% of $1000 = $60 / $1010 = 5.94%
The most commonly referenced yield measure is known as the? What are two other terms used for (1)?
1. Yield to Maturity
2. Yield to Redemption OR Redemption Yield
The Yield to Maturity is the internal rate of return on a bond's expected cash flows - that is, the discount rate that equates the present value of the bond's expected cash flows until maturity with the bond's price. The yield to maturity can be considered an estimate of the bond's expected return; it reflects the annual return that an investor will earn on a bond if this investor purchases the bond today and holds it until maturity.
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There is an ____________ relationship between the bond's price and its yield to maturity, all else being equal?
Inverse
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