Podcast
Questions and Answers
What happens to bond yields when interest rates rise?
What happens to bond yields when interest rates rise?
- They fluctuate randomly
- They decrease
- They increase (correct)
- They remain unchanged
When interest rates fall, how do bond prices react?
When interest rates fall, how do bond prices react?
- They decrease
- They increase (correct)
- They become volatile
- They remain constant
If a bond's coupon rate is fixed at 3%, what occurs if the market interest rate rises?
If a bond's coupon rate is fixed at 3%, what occurs if the market interest rate rises?
- The bond price must increase
- The coupon payments decrease
- The bond price must decrease (correct)
- The yield becomes irrelevant
In the case of a 1% increase in interest rates, what is the price change of a 3% bond?
In the case of a 1% increase in interest rates, what is the price change of a 3% bond?
What does a bondholder receive when market interest rates change?
What does a bondholder receive when market interest rates change?
What calculation method is used to determine the percentage change in yield when interest rates increase?
What calculation method is used to determine the percentage change in yield when interest rates increase?
What is the effect on the yield of a bond if the price of the bond is lowered?
What is the effect on the yield of a bond if the price of the bond is lowered?
What happens to bond prices when interest rates rise?
What happens to bond prices when interest rates rise?
Which type of bonds is generally more volatile in terms of price percentage change?
Which type of bonds is generally more volatile in terms of price percentage change?
What is the relationship between bond yields and bond prices?
What is the relationship between bond yields and bond prices?
What is the primary focus of sell-side fixed-income trading?
What is the primary focus of sell-side fixed-income trading?
During a bond price decrease, what happens to the bond yield assuming the coupon rate remains constant?
During a bond price decrease, what happens to the bond yield assuming the coupon rate remains constant?
When do Government of Canada T-bills settle?
When do Government of Canada T-bills settle?
What does the upward sloping yield curve indicate according to the expectations theory?
What does the upward sloping yield curve indicate according to the expectations theory?
How does interest on a bond accrue in relation to settlement dates?
How does interest on a bond accrue in relation to settlement dates?
What role do bond indexes serve in the bond market?
What role do bond indexes serve in the bond market?
According to the liquidity preference theory, why do investors prefer short-term bonds?
According to the liquidity preference theory, why do investors prefer short-term bonds?
What does a humped yield curve indicate about future interest rates?
What does a humped yield curve indicate about future interest rates?
Under what condition will an investor venture into longer-term bonds according to liquidity preference theory?
Under what condition will an investor venture into longer-term bonds according to liquidity preference theory?
How can the yield curve reflect market consensus about expected future interest rates?
How can the yield curve reflect market consensus about expected future interest rates?
What does the statement 'one-year rates at 4% and two-year rates at 5%' imply for future interest rates?
What does the statement 'one-year rates at 4% and two-year rates at 5%' imply for future interest rates?
Which theory does not provide an explanation for a downward sloping yield curve?
Which theory does not provide an explanation for a downward sloping yield curve?
What is the main focus of market segmentation theory in the fixed-income market?
What is the main focus of market segmentation theory in the fixed-income market?
What does the equation $2 Year Return = 1 Year Return (Year 1) * 1 Year Return (Year 2)$ illustrate?
What does the equation $2 Year Return = 1 Year Return (Year 1) * 1 Year Return (Year 2)$ illustrate?
What is the change in price for Bond B if its duration is 5 and the interest rate drops by 0.75%?
What is the change in price for Bond B if its duration is 5 and the interest rate drops by 0.75%?
Which of the following is NOT a service provided by sell-side institutions in fixed-income trading?
Which of the following is NOT a service provided by sell-side institutions in fixed-income trading?
If the duration of a bond increases, what is the expected change in its price for a given interest rate change?
If the duration of a bond increases, what is the expected change in its price for a given interest rate change?
What is primarily discussed in the courses IMT, PMT, and WME?
What is primarily discussed in the courses IMT, PMT, and WME?
How do sell-side and buy-side operations typically differ?
How do sell-side and buy-side operations typically differ?
If a bond has a duration of 4 and the interest rates increase by 1.2%, what is the expected change in its price?
If a bond has a duration of 4 and the interest rates increase by 1.2%, what is the expected change in its price?
What is the main role of investment bankers in the bond market?
What is the main role of investment bankers in the bond market?
Why might the duration of a bond change over time?
Why might the duration of a bond change over time?
What is a key disadvantage of using duration as a measure of interest rate sensitivity?
What is a key disadvantage of using duration as a measure of interest rate sensitivity?
In fixed-income trading, what primarily happens on the buy side?
In fixed-income trading, what primarily happens on the buy side?
What is the primary function of the retail desk?
What is the primary function of the retail desk?
What is usually necessary for executing large trades or dealing with illiquid securities?
What is usually necessary for executing large trades or dealing with illiquid securities?
What distinguishes firms with a large institutional dealing desk from those without?
What distinguishes firms with a large institutional dealing desk from those without?
What do inter-dealer brokers primarily do?
What do inter-dealer brokers primarily do?
How do inter-dealer brokers contribute to price discovery?
How do inter-dealer brokers contribute to price discovery?
Which of the following tasks is NOT typically performed by inter-dealer brokers?
Which of the following tasks is NOT typically performed by inter-dealer brokers?
What role does a proprietary trading system play for advisors?
What role does a proprietary trading system play for advisors?
What is one characteristic of firms that do not have a large institutional dealing desk?
What is one characteristic of firms that do not have a large institutional dealing desk?
Which statement is accurate regarding the trading volumes in Canada?
Which statement is accurate regarding the trading volumes in Canada?
What function do inter-dealer brokers perform in relation to trade execution?
What function do inter-dealer brokers perform in relation to trade execution?
Study Notes
Bond Return Calculation
- 2 Year Return is calculated as: 2 Year Return = 1 Year Return (Year 1) × 1 Year Return (Year 2).
- Given rates: 1 Year Return (Year 1) = 4% and 2 Year Return = 5%, the calculation derives a future one-year rate of approximately 6%.
Expectations Theory
- An upward sloping yield curve suggests expectations of rising interest rates.
- A downward sloping yield curve indicates expected falling rates.
- A humped curve signifies that rates may increase before decreasing.
Liquidity Preference Theory
- Investors favor short-term bonds for their liquidity and reduced volatility.
- Longer-term bonds are considered if compensated adequately for risks associated with liquidity and price volatility.
- This theory cannot satisfactorily explain a downward sloping yield curve.
Market Segmentation Theory
- Involves institutional players focusing on specific term sectors within the fixed-income market.
Bond Prices and Interest Rates Relationship
- Bond prices and yields have an inverse relationship: as interest rates rise, bond yields increase while prices decrease.
- For bonds, yields and interest rates are synonymous.
- Price adjustments occur since coupon rates remain constant.
Bond Price Sensitivity
- Price sensitivity of bonds depends on duration; longer-duration bonds can be more volatile.
- An example shows a 5-year bond experiences a 2.5% price change with a 0.50% interest rate drop.
Bond Market Trading
- Trading involves two sides: sell side (investment dealers) and buy side (institutional clients).
Sell Side Functions
- Sell side handles the creation, marketing, and trading of fixed-income products.
- Investment bankers assist with structuring and introducing new debt issues.
Trading in Non-Institutional Firms
- Smaller firms may rely on external trading desks to build product inventories rather than having large internal inventories.
Role of Inter-Dealer Brokers
- Brokers facilitate trades between institutional buyers and sellers, aiding in price discovery and execution.
- They enhance market transparency and execute trades in the wholesale bond market.
Price Movement Dynamics
- Price volatility is greater in longer-term and lower coupon rate bonds.
- Interest on bonds is accrued post prior payment to the settlement day.
Bond Indexes
- Used for assessing the performance of the bond market or specific segments.
- Serve as benchmarks for bond portfolio managers and in the construction of bond index funds.
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Description
This quiz explores the calculations and theories related to bond returns, including the Bond Return Calculation, Expectations Theory, Liquidity Preference Theory, and Market Segmentation Theory. It simplifies complex concepts and encourages understanding of how interest rates influence bond pricing and investment strategies.
