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Questions and Answers
What does Yield to Maturity (YTM) represent?
What does Yield to Maturity (YTM) represent?
How is Current Yield calculated?
How is Current Yield calculated?
What is the primary consequence of rising interest rates for existing bonds?
What is the primary consequence of rising interest rates for existing bonds?
What does Total Return account for in bond investments?
What does Total Return account for in bond investments?
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Which type of bond risk refers to the possibility of an issuer failing to make payments?
Which type of bond risk refers to the possibility of an issuer failing to make payments?
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How does inflation impact the real return on an investment in bonds?
How does inflation impact the real return on an investment in bonds?
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What effect do rising interest rates typically have on existing bond prices?
What effect do rising interest rates typically have on existing bond prices?
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How can an investor calculate the real rate of return?
How can an investor calculate the real rate of return?
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What causes liquidity risk in bond investments?
What causes liquidity risk in bond investments?
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Which factor does NOT influence bond returns?
Which factor does NOT influence bond returns?
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What occurs in reinvestment risk when interest rates drop?
What occurs in reinvestment risk when interest rates drop?
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What is call risk associated with callable bonds?
What is call risk associated with callable bonds?
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In the context of bond investments, what is the significance of credit risk?
In the context of bond investments, what is the significance of credit risk?
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Which risk affects the entire market rather than individual securities?
Which risk affects the entire market rather than individual securities?
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If a bond has a face value of $1,000 and pays $100 annually, what is its coupon rate?
If a bond has a face value of $1,000 and pays $100 annually, what is its coupon rate?
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What is a significant risk when bonds cannot be easily sold?
What is a significant risk when bonds cannot be easily sold?
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What are the two main cash flows that bonds return to their investors?
What are the two main cash flows that bonds return to their investors?
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How does the presence of a floating-rate coupon affect a bond's risk profile?
How does the presence of a floating-rate coupon affect a bond's risk profile?
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Which of the following features would NOT increase the risk of a bond?
Which of the following features would NOT increase the risk of a bond?
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Why is Yield to Maturity (YTM) considered a comprehensive measure of a bond's return?
Why is Yield to Maturity (YTM) considered a comprehensive measure of a bond's return?
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What aspect of bonds distinguishes their expected cash flows from those of stocks?
What aspect of bonds distinguishes their expected cash flows from those of stocks?
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In evaluating bonds, which of the following bond features would typically lead to a higher expected return?
In evaluating bonds, which of the following bond features would typically lead to a higher expected return?
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What does the term 'face value' refer to in the context of bonds?
What does the term 'face value' refer to in the context of bonds?
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What is one primary reason bond analysis is crucial despite the presence of bond-rating systems?
What is one primary reason bond analysis is crucial despite the presence of bond-rating systems?
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What is a specific form of credit risk associated with a bond issuer failing to meet payment obligations?
What is a specific form of credit risk associated with a bond issuer failing to meet payment obligations?
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How does a downgrade in a bond's credit rating generally impact its market price?
How does a downgrade in a bond's credit rating generally impact its market price?
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Which factor does NOT directly impact a bond's risk profile?
Which factor does NOT directly impact a bond's risk profile?
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What does the coupon rate of a bond refer to?
What does the coupon rate of a bond refer to?
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What happens to bond prices when interest rates rise?
What happens to bond prices when interest rates rise?
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What does the face value of a bond represent?
What does the face value of a bond represent?
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Which of the following strategies can help mitigate bond-related risks?
Which of the following strategies can help mitigate bond-related risks?
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Which risk involves investors facing potential loss due to the issuer's change in credit rating?
Which risk involves investors facing potential loss due to the issuer's change in credit rating?
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What does the immunization strategy aim to achieve in a bond portfolio?
What does the immunization strategy aim to achieve in a bond portfolio?
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Which strategy involves choosing bonds that mature when cash is needed?
Which strategy involves choosing bonds that mature when cash is needed?
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What is a primary characteristic of active bond management?
What is a primary characteristic of active bond management?
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What advantage do bond ETFs provide to investors?
What advantage do bond ETFs provide to investors?
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What risk can increase if all bonds in a portfolio mature at the same time?
What risk can increase if all bonds in a portfolio mature at the same time?
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What does yield represent for a bond?
What does yield represent for a bond?
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Which bond strategy helps to mitigate both interest rate and reinvestment risks?
Which bond strategy helps to mitigate both interest rate and reinvestment risks?
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How does a Buy-and-Hold Strategy primarily protect investors?
How does a Buy-and-Hold Strategy primarily protect investors?
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What does the Bond Barbell Strategy typically involve?
What does the Bond Barbell Strategy typically involve?
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Which of the following risks is specifically associated with the Buy-and-Hold Strategy?
Which of the following risks is specifically associated with the Buy-and-Hold Strategy?
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What is a defining feature of covenants in bond investing?
What is a defining feature of covenants in bond investing?
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Why do investors use a Bond Bullet Strategy?
Why do investors use a Bond Bullet Strategy?
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What is the primary advantage of liquidity in bond markets?
What is the primary advantage of liquidity in bond markets?
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Study Notes
Debt Securities Market - Bond Market (Part 2)
- Learning Outcomes: Evaluate bonds, identify bond features affecting risk/return, and establish an investment strategy
- Introduction: This module continues the previous topic.
Bond Value
- Bond analysis focuses on value, which depends on expected return and its certainty
- Bonds give two cash flows: coupon payments (usually twice yearly), and principal repayment at maturity.
- Coupon rate and face value are specified in the bond itself
- Unlike stocks, the cash flows of bond are established initially, making risk related to uncertainties. Floating-rate or callable bonds are examples of bonds with uncertain cash flows, thus increasing their risk to investors.
- Bond features determine return and risk for investors
Bond Returns
- Bond returns come from coupon payments and price appreciation/depreciation
- Yield to Maturity (YTM): The total return assuming all coupons are reinvested at the same rate.
- Current Yield: Annual coupon payment divided by current market price.
- Total Return: Includes coupon payments, capital gains/losses, and transaction costs.
Factors Influencing Bond Returns
- Interest Rates: Inverse relationship between bond prices and interest rates. Rising rates decrease bond prices and increase yields, and vice versa.
- Inflation: Inflation decreases real return; nominal return minus inflation rate equals real return.
- Credit Risk: Issuer's creditworthiness impacts yields. Higher risk bonds require higher yields.
Bond Risks
- Interest Rate Risk: Existing bond prices fall when interest rates rise, as new bonds are issued at higher rates, making older ones less attractive.
- Credit Risk (Default Risk): Risk that the bond issuer fails to meet payment obligations.
- Inflation Risk: Inflation erodes the purchasing power of fixed income from bonds.
- Liquidity Risk: Difficulty in selling a bond without significant loss in value.
- Reinvestment Risk: Cash flows cannot be reinvested at the same rate, especially if prevailing rates fall.
- Call Risk: Investors may not receive the yield they expect if a callable bond is called.
- Market/Systematic Risk: Risks affecting entire market rather than individual securities.
Bond Characteristics and Strategies
- Issuer: Government, municipality, or corporation.
- Maturity Date: Date when the bond must be repaid
- Coupon Rate: Annual interest paid
- Face Value: Amount repaid at maturity
- Bond Price: Market price, inversely related to interest rates.
- Yield: Return on investment, varying with price and coupon payments
- Liquidity: How easy a bond is to sell
- Covenants: Agreements protecting investor interest
- Buy and Hold Strategy: Holding bonds until maturity, mitigating liquidity and interest rate risks.
- Bond Laddering Strategy: Purchasing bonds with staggered maturities to reinvest interest and mitigate risk.
- Bond Barbell Strategy: Combining short-term and long-term bonds to reduce intermediate-term maturities.
- Bond Bullet Strategy: Buying multiple bonds with similar maturities, aligning with cash needs.
- Immunization Strategy: Matching portfolio duration with investment horizon to stabilize value despite rate changes.
- Cash Flow Matching Strategy: Choosing bonds with maturities aligned with future cash flow needs.
- Active Management Strategy: Using forecasts and market conditions to maximize returns, though increased risk.
- Bond ETFs: Exposure to diversified bond portfolios through exchange-traded funds.
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Description
Test your knowledge on bond investments, including concepts like Yield to Maturity, current yield, and various types of risks associated with bonds. This quiz covers critical factors affecting bond pricing and returns, making it essential for anyone looking to understand bond markets more comprehensively.
