Podcast
Questions and Answers
What characterizes money market securities?
What characterizes money market securities?
- High credit risk and long-term maturity
- Low liquidity and high default risk
- Short-term maturity and high liquidity (correct)
- Long-term maturity and low liquidity
Which entity is least likely to participate in the money market to obtain cash?
Which entity is least likely to participate in the money market to obtain cash?
- A corporation financing its day-to-day operations
- A government covering a short-term budget deficit
- A pension fund investing for long-term growth (correct)
- The Federal Reserve executing monetary policy
Which of the following is NOT a typical characteristic of money market instruments?
Which of the following is NOT a typical characteristic of money market instruments?
- Sold at a discount
- Maturity of one year or less
- High default risk (correct)
- Large denomination
Which of the following best describes the role of money markets for investors/lenders?
Which of the following best describes the role of money markets for investors/lenders?
What is the primary reason a non-financial institution might utilize the money markets?
What is the primary reason a non-financial institution might utilize the money markets?
What is the primary function of the U.S. Treasury Department in money markets?
What is the primary function of the U.S. Treasury Department in money markets?
What role do money market mutual funds play in the money market?
What role do money market mutual funds play in the money market?
Which of the following is TRUE regarding money market securities?
Which of the following is TRUE regarding money market securities?
What is the key feature of Treasury Bills that distinguishes them from other money market instruments?
What is the key feature of Treasury Bills that distinguishes them from other money market instruments?
How is the implied interest earned on a Treasury Bill determined?
How is the implied interest earned on a Treasury Bill determined?
A Treasury Bill is purchased for $9,850 and has a face value of $10,000. What is the implied interest?
A Treasury Bill is purchased for $9,850 and has a face value of $10,000. What is the implied interest?
Which rate is used in the official pricing of Treasury bills?
Which rate is used in the official pricing of Treasury bills?
According to the provided formula, which variable expresses the number of days until maturity?
According to the provided formula, which variable expresses the number of days until maturity?
Which convention is used when calculating the yield by discount rate?
Which convention is used when calculating the yield by discount rate?
A Treasury bill with a face value of $10,000 is purchased for $9,900 and matures in 180 days. Calculate the discount rate.
A Treasury bill with a face value of $10,000 is purchased for $9,900 and matures in 180 days. Calculate the discount rate.
A Treasury bill with a face value of $10,000 is purchased for $9,900 and matures in one year. Which formula would provide a more accurate estimate of the yield?
A Treasury bill with a face value of $10,000 is purchased for $9,900 and matures in one year. Which formula would provide a more accurate estimate of the yield?
Which of the following is the correct interpretation of the formula $P = F(1 - i_{discount} * (n / 360))$ in the context of Treasury Bills?
Which of the following is the correct interpretation of the formula $P = F(1 - i_{discount} * (n / 360))$ in the context of Treasury Bills?
What is commercial paper?
What is commercial paper?
What is the typical maturity range for commercial paper?
What is the typical maturity range for commercial paper?
A certificate of deposit (CD) is issued by what type of institution?
A certificate of deposit (CD) is issued by what type of institution?
Compared to commercial paper, how does the risk and return of CDs generally compare?
Compared to commercial paper, how does the risk and return of CDs generally compare?
What is a repurchase agreement (repo)?
What is a repurchase agreement (repo)?
In a repurchase agreement, what happens if the borrower defaults?
In a repurchase agreement, what happens if the borrower defaults?
In a repurchase agreement, what is the term 'haircut' referring to?
In a repurchase agreement, what is the term 'haircut' referring to?
Which parties are typically involved in interbank lending?
Which parties are typically involved in interbank lending?
What is the primary purpose of interbank lending for banks?
What is the primary purpose of interbank lending for banks?
How can central banks indirectly influence the interbank rate?
How can central banks indirectly influence the interbank rate?
Which of the following statements is correct? (Assume Rate_TB is treasury bill interest rate, Rate_FF is the federal funds rate)
Which of the following statements is correct? (Assume Rate_TB is treasury bill interest rate, Rate_FF is the federal funds rate)
Which of the following is NOT a characteristic of a bond?
Which of the following is NOT a characteristic of a bond?
What are the two key characteristics of a bond?
What are the two key characteristics of a bond?
Which of the following entities can issue bonds?
Which of the following entities can issue bonds?
Which of the following entities is a common investor in bonds?
Which of the following entities is a common investor in bonds?
What does 'par value' refer to in the context of a bond?
What does 'par value' refer to in the context of a bond?
A bond that pays a variable-rate coupon is also known as what?
A bond that pays a variable-rate coupon is also known as what?
What is a 'green bond' used for?
What is a 'green bond' used for?
All else equal, how does the interest rate for corporate bonds rated AAA compare to those rated BBB?
All else equal, how does the interest rate for corporate bonds rated AAA compare to those rated BBB?
How are bonds with a rating below BBB classified?
How are bonds with a rating below BBB classified?
Which factor does S&P consider when assigning credit ratings to companies?
Which factor does S&P consider when assigning credit ratings to companies?
Which rating signifies the highest credit quality and the smallest degree of investment risk?
Which rating signifies the highest credit quality and the smallest degree of investment risk?
What does duration measure in the context of bonds?
What does duration measure in the context of bonds?
If a bond is selling at a premium, how does its coupon rate compare to its yield to maturity (YTM)?
If a bond is selling at a premium, how does its coupon rate compare to its yield to maturity (YTM)?
Which action would cause a change in bonds?
Which action would cause a change in bonds?
All else being equal, which of the following would result in a lower yield asked by investors?
All else being equal, which of the following would result in a lower yield asked by investors?
Given the formula $PV = \frac{C}{i}(1 - \frac{1}{(1 + i)^n}) + \frac{F}{(1 + i)^n}$, if the coupon (C) and all other variables except i remain constant, what will happen to the Present Value (PV) as i increases?
Given the formula $PV = \frac{C}{i}(1 - \frac{1}{(1 + i)^n}) + \frac{F}{(1 + i)^n}$, if the coupon (C) and all other variables except i remain constant, what will happen to the Present Value (PV) as i increases?
Which of the following is the most accurate description of why an investor might demand a higher yield (YTM) for a particular bond?
Which of the following is the most accurate description of why an investor might demand a higher yield (YTM) for a particular bond?
What is the implied economic relationship that would cause the spread between lower rated credit bond and the risk-free treasury of the same maturity to widen significantly?
What is the implied economic relationship that would cause the spread between lower rated credit bond and the risk-free treasury of the same maturity to widen significantly?
A bond is issued with a par value of $1,000 and a coupon rate of 5%, paid semi-annually. If an investor buys the bond for $950, which of the following is true?
A bond is issued with a par value of $1,000 and a coupon rate of 5%, paid semi-annually. If an investor buys the bond for $950, which of the following is true?
A highly sophisticated, algorithmic trading firm detects a minuscule price discrepancy between two bonds with otherwise identical characteristics - same issuer, maturity, coupon rate, and credit rating, but one is USD denominated and the other is EUR denominated. The price of the USD-denominated bond is slightly higher. Which strategy would most likely be engaged by the firm to exploit this opportunity, assuming minimal transaction costs?
A highly sophisticated, algorithmic trading firm detects a minuscule price discrepancy between two bonds with otherwise identical characteristics - same issuer, maturity, coupon rate, and credit rating, but one is USD denominated and the other is EUR denominated. The price of the USD-denominated bond is slightly higher. Which strategy would most likely be engaged by the firm to exploit this opportunity, assuming minimal transaction costs?
Which of the following best exemplifies the role of debt markets for a company needing to manage short-term operational costs?
Which of the following best exemplifies the role of debt markets for a company needing to manage short-term operational costs?
What is a key difference between how a company addresses short-term funding needs versus long-term expansion plans in debt markets?
What is a key difference between how a company addresses short-term funding needs versus long-term expansion plans in debt markets?
If a company needs to borrow funds for 75 days to cover raw material costs, which market would it most likely use?
If a company needs to borrow funds for 75 days to cover raw material costs, which market would it most likely use?
In European markets, which entity typically replaces the role of the U.S. Federal Reserve in its interactions with money markets?
In European markets, which entity typically replaces the role of the U.S. Federal Reserve in its interactions with money markets?
Apple has a large amount of cash and short-term investments. Where doesn't Apple keep the majority of these funds?
Apple has a large amount of cash and short-term investments. Where doesn't Apple keep the majority of these funds?
Why is the term "money market" considered a misnomer?
Why is the term "money market" considered a misnomer?
What are the typical characteristics of money market instruments in terms of denomination, risk, and maturity?
What are the typical characteristics of money market instruments in terms of denomination, risk, and maturity?
What is the fundamental purpose of money market for investors (lenders)?
What is the fundamental purpose of money market for investors (lenders)?
For a non-financial corporation, what is the most likely reason for using money markets?
For a non-financial corporation, what is the most likely reason for using money markets?
Apart from controlling interest rates, what is another key role of the Federal Reserve System in the money market concerning U.S. Treasury securities?
Apart from controlling interest rates, what is another key role of the Federal Reserve System in the money market concerning U.S. Treasury securities?
Which statement accurately describes Treasury Bills?
Which statement accurately describes Treasury Bills?
How do investors profit from Treasury Bills, given that they do not pay explicit interest?
How do investors profit from Treasury Bills, given that they do not pay explicit interest?
A Treasury Bill with a face value of $10,000 is purchased for $9,750 and matures in 180 days. Using the discount rate method, which of the following is closest to the discount yield?
A Treasury Bill with a face value of $10,000 is purchased for $9,750 and matures in 180 days. Using the discount rate method, which of the following is closest to the discount yield?
What is the role of the discount rate in the pricing of Treasury Bills?
What is the role of the discount rate in the pricing of Treasury Bills?
Which formula gives the price P of a Treasury Bill, where F is the face value, idiscount is the discount rate, and n is the number of days until maturity?
Which formula gives the price P of a Treasury Bill, where F is the face value, idiscount is the discount rate, and n is the number of days until maturity?
In T-Bill yield calculations, what is the purpose of using a 360-day year convention when calculating the discount rate?
In T-Bill yield calculations, what is the purpose of using a 360-day year convention when calculating the discount rate?
A company requires short-term financing, and issues commercial paper. Which entities are most likely to purchase this?
A company requires short-term financing, and issues commercial paper. Which entities are most likely to purchase this?
What is the maximum maturity that commercial paper can have to be considered a money market instrument?
What is the maximum maturity that commercial paper can have to be considered a money market instrument?
When a certificate of deposit is issued, which entity is responsible for issuing it?
When a certificate of deposit is issued, which entity is responsible for issuing it?
What is the impact for investors when CD's are issued by financial institutions that are generally more regulated and less risky than corporations that issue commercial paper?
What is the impact for investors when CD's are issued by financial institutions that are generally more regulated and less risky than corporations that issue commercial paper?
If a bank is using a repurchase agreement (repo), what are they doing?
If a bank is using a repurchase agreement (repo), what are they doing?
In a repurchase agreement, what does the lender receive on day 1?
In a repurchase agreement, what does the lender receive on day 1?
What is the primary role of collateral (e.g., government securities) in a repurchase agreement in relation to the borrower?
What is the primary role of collateral (e.g., government securities) in a repurchase agreement in relation to the borrower?
In the interbank lending market, what is being transferred?
In the interbank lending market, what is being transferred?
What is the typical loan period when banks use the interbank lending market?
What is the typical loan period when banks use the interbank lending market?
What is the main reason banks participate in the interbank lending market?
What is the main reason banks participate in the interbank lending market?
How do central banks indirectly influence the interbank lending rate?
How do central banks indirectly influence the interbank lending rate?
What defines a long-term debt security and enables corporations to finance long-term projects?
What defines a long-term debt security and enables corporations to finance long-term projects?
In the context of bonds, what does the term 'maturity' refer to?
In the context of bonds, what does the term 'maturity' refer to?
What is unique about floating-rate bonds compared to traditional fixed-rate bonds?
What is unique about floating-rate bonds compared to traditional fixed-rate bonds?
If an investor is particularly concerned about environmental sustainability, which type of bond would align with their investment objectives?
If an investor is particularly concerned about environmental sustainability, which type of bond would align with their investment objectives?
How does a bond's credit rating generally affect its required interest rate (yield)?
How does a bond's credit rating generally affect its required interest rate (yield)?
A fixed-rate bond is issued at its par value with a coupon rate of 6%. Years later, market yield rates for bonds of comparable risk have increased to 8%. What will likely happen to this bond's price in the secondary market?
A fixed-rate bond is issued at its par value with a coupon rate of 6%. Years later, market yield rates for bonds of comparable risk have increased to 8%. What will likely happen to this bond's price in the secondary market?
Which of the following actions by the Federal Reserve would most likely increase bond prices across the market?
Which of the following actions by the Federal Reserve would most likely increase bond prices across the market?
Suppose an investor is considering two bonds with similar credit ratings and maturities. Bond A is highly liquid, whereas Bond B is relatively illiquid. Which bond would likely have a higher yield, all else being equal?
Suppose an investor is considering two bonds with similar credit ratings and maturities. Bond A is highly liquid, whereas Bond B is relatively illiquid. Which bond would likely have a higher yield, all else being equal?
An investor is considering purchasing a bond. What situation is MOST likely to cause them to demand a higher yield (YTM)?
An investor is considering purchasing a bond. What situation is MOST likely to cause them to demand a higher yield (YTM)?
If concerns heightened substantially regarding the long-term financial solvency of several large technology companies that had previously enjoyed exemplary credit ratings, influencing spreads; how would this translate?
If concerns heightened substantially regarding the long-term financial solvency of several large technology companies that had previously enjoyed exemplary credit ratings, influencing spreads; how would this translate?
A corporate bond is issued bearing a "100-year storm" clause, which stipulates that in the event of a climate event causing damages exceeding 5% of the issuer’s total assets, the coupon payment is automatically deferred for one year. How would such a clause MOST likely affect the bond's pricing?
A corporate bond is issued bearing a "100-year storm" clause, which stipulates that in the event of a climate event causing damages exceeding 5% of the issuer’s total assets, the coupon payment is automatically deferred for one year. How would such a clause MOST likely affect the bond's pricing?
What is a 'zero coupon' bond?
What is a 'zero coupon' bond?
What does the credit rating of a bond indicate?
What does the credit rating of a bond indicate?
What kind of bonds are often known as "Junk bonds"?
What kind of bonds are often known as "Junk bonds"?
What is the implication for bonds with a higher liquidity on the market?
What is the implication for bonds with a higher liquidity on the market?
Why is default risk important on bonds?
Why is default risk important on bonds?
Flashcards
What are debt markets?
What are debt markets?
Markets where short-term debt instruments are traded.
What is the money market?
What is the money market?
Market for short-term debt securities (maturity of one year or less).
What are Treasury Bills?
What are Treasury Bills?
Debt securities issued by the U.S. Treasury to cover government budget shortfalls and sold at a discount from the par amount.
What is commercial paper?
What is commercial paper?
Signup and view all the flashcards
What is a Repurchase Agreement (Repo)?
What is a Repurchase Agreement (Repo)?
Signup and view all the flashcards
What is the interbank market?
What is the interbank market?
Signup and view all the flashcards
What is a bond?
What is a bond?
Signup and view all the flashcards
What are coupons?
What are coupons?
Signup and view all the flashcards
What is bond maturity?
What is bond maturity?
Signup and view all the flashcards
What are convertible bonds?
What are convertible bonds?
Signup and view all the flashcards
What are Eurobonds?
What are Eurobonds?
Signup and view all the flashcards
What are green bonds?
What are green bonds?
Signup and view all the flashcards
What is the coupon interest rate?
What is the coupon interest rate?
Signup and view all the flashcards
What is 'face amount'?
What is 'face amount'?
Signup and view all the flashcards
What is maturity (in bonds)?
What is maturity (in bonds)?
Signup and view all the flashcards
What is yield to maturity?
What is yield to maturity?
Signup and view all the flashcards
What is credit/default risk?
What is credit/default risk?
Signup and view all the flashcards
What is 'Junk Bonds'?
What is 'Junk Bonds'?
Signup and view all the flashcards
What is interest rate risk?
What is interest rate risk?
Signup and view all the flashcards
Study Notes
Debt Markets
- Companies may need short-term and long-term debt to effectively run their business
- Financing can be obtained through a financial intermediary like a commercial bank
- Short-term debt can be funded via money markets
- Long-term financing can be done through the bond market
- Any debt increases must be accounted for
Note on US and EU markets
- Text and figures are from American markets
- These can be translated to European market analysis
- Simply switch $ to €
- Simply switch Fed or Federal Reserve to ECB or European Central Bank
- Simply switch US Treasury Department to National Treasuries
Course Content - Debt Market - Money and Bond Markets
- Topics for Session 2 are about the debt market
- Part 2.1 relates to money markets
- Part 2.2 relates to bond markets
Apple's Balance Sheet
- Apple's financial data is used as an example of money market instruments
- As of 2017, Apple had $74 billion in cash and short-term securities
- Almost $8 billion was deposited at banks
- "$12.3 billion was in ""cash equivalents"""
Money Markets - A misnomer
- Money (currency) is not traded in money markets
- Money market securities are short term and have high liquidity with low credit risk
Money Market Definitions
- Securities are generally sold in large denominations ($1 million+)
- Money markets securities have a low default risk
- Money markets mature in less than a year from their issue date (most mature in under 120 days)
Purpose of Money Markets
- Money markets provide a vehicle for investors/lenders to warehouse excess funds and get a return
- Money markets let borrowers to sell securities and receive low-cost funds
Money Market usage
- Cash payments and incomes are not always synchronized
- Asynchronization of cash flow causes cash shortages
- Money markets solve these cash timing problems
Non-financial Institutions - Example
- A manufacturer must pay for inputs, employees, and storage
- Manufacturers get paid weeks after the goods are sold
- Cash flow asynchronization can be settled by borrowing in the money markets
Money Market Participants
- US Treasury sells securities to fund the national debt
- Federal Reserve buys/sells US Treasury securities to control interest rates
- Commercial banks buy US Treasury securities and sell CDs, make short-term loans, and offer money market investment accounts
- Businesses buy and sell short-term securities
- Investment firms trade on behalf of commercial accounts
- Finance companies lend funds to individuals
- Insurance companies maintain liquidity for unexpected demands
- Pension funds invest in money market instruments for future stock and bond investments
- Individuals buy money market mutual funds
- Money market mutual funds let small investors participate investing in large-denomination money markets
Federal Reserve's Exception
- Most participants sell to obtain cash
- The Federal Reserve is an important exception
- The Federal Reserve buys/sells T-bills to influence monetary policy
Money Market Instruments
- Focus areas are Treasury Bills, Commercial Paper/Certificates of Deposit, Repurchase Agreements and the Interbank Market
Treasury Bills
- Debt securities issued by the US Treasury to cover budget deficits
- Treasury Bills are sold at a discount from the par amount
- As an Example, a $1000 bill purchased for $990, would mature at $1000
- The difference between the purchase price and face value is the implied interest
- There is no explicit interest rate in the bill contract
- In France, they are called "Bon du Trésor à taux fixe et à intérêt précompté" or BTF
Treasury Bills - Maturities, Liquidity, Default Risk, and FAQ
- Treasury bills have terms of 4, 13, 26, and 52 weeks.
- Treasury bills are auctioned regularly (every Thursday)
- Treasury bills have a very liquid secondary market, and virtually no default risk
Treasury Bills and Discount Rates
- All money market securities do not pay interest, but sell at a discount
- An increase in price at maturity provides a return
- Treasury bills are priced with discount rates
Solving for the discounted Treasury Bills price
- i = discount rate
- n = number of days until maturity
- Debt securities have specific interest rate and day-count conventions
Idscount Understates the Return
- An Idscount can understate the return
But we want a formula for Return with Duration
Better Yield Estimates for T-Bills (T-Bill Rate)
- F is the face value of the bill
- P is the purchase price of the bill
- i is the bill's discount rate
- n is the number of days until maturity
Treasury Bill Rates Example
- Purchasing a 28-day T-bill discounted at $996.37
- T- Bill worth $1000 at maturity
Historic Treasury Bill Interest Rate and the Rate of Inflation
- Treasury Bill Interest Rate and the Inflation Rate, January 1973-January 2016
- Inflation is lower now than it was in the late 70s, early 80s
Commercial Paper / Certificates of Deposits
- A "Commercial Paper" is a note issued by a credit-worthy corporation
- Commercial papers are generally issued by corporations
- Maturities are up to 270 days (average around 30 days)
- The use of commercial papers increased due to rising costs of loans in early 1980s
- There has been decreased use due to economic recession
- The annual market is still worth more than $0.85 trillion outstanding
Return on Commercial Paper and the Prime Rate
- Graph of the Return on Commercial Paper and the Prime Rate 1990-April 2016
- The prime rate is the interest rate that commercial banks charge creditworthy customers
Commercial Paper Issued By Financial Institutions
- A "Certificate of Deposit (CD)" is a commercial paper issued by a financial institution like a bank or credit union
- CD's have longer durations, but they must be less than 3 years
- Financial institutions are more regulated, so it's less risky than corporations, so the return of CDs is often lower than the return of CPs
Repurchase Agreements (repos)
-
This is a form of collateralized short-term borrowing
-
The seller buys back securities at an agreed-upon price at a later date
-
An overnight repo happens over two days, Day 0 and Day 1
Overnight Repo: the Collateral
- One party borrows and posts something for collateral
- The collateral is often government securities
- The borrower gives cash in a no default situation on day 1, and the lender returns the collateral and resells the securities
- If the borrower can't pay back the cash, the lender has the right to sell collateral
- Reduced risk = Lower rate to pay on the loan
Other Aspects of Repos
- Borrowers get less than what the collateral is worth
- This difference is the "haircut"
- It is common is large institutions and with government securities
- Repos are extensively used by companies and don't force the selling of assets and reinvesting later
Interbank Market
-
This deals with short-term funds transferred between institutions
-
Interbank markets allow banks to meet the reserve requirements
-
Central Banks (Federal Reserve, European Central Bank) all have minimum reserve amounts banks must meet
-
Banks with excess reserves will lend to banks "overnight" that need the reserves
-
In France, this known as "marché interbancaire", and in the USA: “Fed Funds”
The Fed Funds Market
- Name is misleading
- It comes from the fund holdings with the Federal Reserve that banks can access
- The average interest rate on these transactions is a benchmark rate called the interbank rate
- Supply and demand determine this interest rate, so it can't be directly controlled
- The Central Banks can indirectly manipulate via adjusting reserve levels
- Purchasing helps the banks and restart the economy
Interest Rates Analysis
- Interbank market and Treasury Bill Interest Rates, January 1990-April 2016
- Compares treasury bills vs federal funds over time
- Interest Rates on Money Market Securities, 1990-2016
- Compares trends for federal funds, treasury bills, certificates of deposit and commercial paper
Bond Markets - Bonds Defined
- A bond is a long-term debt security (> 1 year)
- Bonds allow issuers to borrow for long-term financing or investments through investors
- Issuers make regular coupon payments
- Bond issuers pay back the borrowed amount when a bond matures, so is known as 'nominal/principal/face value'
- Coupon and Maturity key bond characteristics
Bond Issuers and Agencies
Governments:
- US Treasury notes and bonds
- UK Gilts
- Germany Bund
- France OAT
- Japan JGB
Corporations:
- Domestic, Eurobonds
- Investment grade versus junk
Government agencies:
- Municipal bonds, local authorities
Bond Buyer
- Pension Funds
- Life Insurance Companies
- Hedge Funds
- Households (mostly through funds)
- Governments (e.g., Japan & China)
Typical Coupon Bonds
- Annual (or semi annual) interest payments in the form of coupons
- At maturity, the issuer pays the par value to the bond holder
- Par value and Coupon Rate are both specified when the bond is issued
- The common "coupon" is constant to the bond holder, annually, or semi-annually
- Sometimes bonds have a variable rate, such as a floating rate bond such as "Euribor 3M in a given currency."
Bond Components in a Chart - Coupon, Maturity, and Face Value Example
- Face value is at the top corner
- Coupon rate is shown to the left
- Maturity is at lower left
Specific Bond Types
- Perpetuals never have the principal repaid and must be sold on the secondary market to recoup payment
- Variable rates have a coupon linked to an interest rate (usually 1yr)
- Mortgages have payments secured against a property like a house
- Callable bonds are purchased back by the issuer, such as when rates decrease
- Puttable bonds are when the investor can them back, usually as rates increase
Bond Types
- Convertibles provide the owner the option to convert the bond into the company's equity, however has higher risk
- Structured bonds provide a complex payment, like "spread notes," which pays three times (rate20Y - rate2Y)
- Zero coupon does not provide any payment, but gives a one time payment of principal at the maturity
- Eurobonds are issued in a non-native currency to the issuer's country, and are usually in USD/EUR
- Green bonds fund exclusively to finance environmental projects as new investments become ever-increasing
Debt Security Ratings for Investors
- US Treasury bills are given out with a maturity date that is less than a year away
- US Treasury Notes offer term lengths from 1 to 10 years
- US Treasury bonds are sold with a maturity date that is between 10 to 30 years
US Treasury Bonds
- Treasury bills are very low risk because the Treasury can print money
- Have low rates with present inflationary risks
- The market is active for the secondary selling
The Bond Rate
- Shows inflation and treasuries
- Treasury Bills have low risk and may have inflation now
- Market is very active
Corporate Bonds
- These are released from companies to investors
- US companies pay semi-annual coupons and some annual ones in Europe
- All bonds vary with each other, based on risk, payment rates, and level
- Lower risk (AAA) to higher risk (BBB)
Bond Ratings and Outlooks
- Quality is indicated by the lower the rating/likelihood is default
- The key evaluation firms are firms Standard & Poor’s, Moody’s and Fitch
- A good rating a "forward-looking opinion about the creditworthiness of an obligor"
- This includes a wide-range of programs and debts for both commercial paper
Rating Breakdown and Investment Indicators
- The better a bond is rated the better
- AAA = extremely strong
- AA = High strength
- A = upper Middle grade
- BBB = Medium grade
Lower bond qualities
- These have lower payments, and are less quality
- B = very risky defaults and interest
- C = non investment degree and can be filed under bankruptcy
- CI = Income bonds are reserved with no payments D is default
Market Rates
- Analyzes data from the market and interest dates
- These can be corporate of fixed bonds
- Analyzes the years
Junk Bonds
- These have ratings lower than BBB investment grade
- These bonds are issued by companies that faced recent financial difficulties
- Trust companies and firms have investments secured in junk debts
- Risk and return rates increase with these values
Bond Pricing Basics
- The prices equal the value and are discounted due to risk
- Includes the key 3 steps and cash flows
- Determines the approximate risk
- Reduce calculated risks at the given rate
PV Formula
𝑅 is the reimbursement price of the bond 𝐶 is the value of the coupons 𝑖 is the bond’s yield to maturity (also called discount rate, internal rate of return, 𝑛 is the maturity of the bond
Computing Price
We have the annual Rate of 10% for 3 years of the investment, rate equals 12%
- We identify the 𝑖 in our formula to calculate the cost of values per year
- We discount
Variant 1: Reimbursement, Variant 2: Maturity
- Reimbursement price is 102% of $1,000,
- Compute the Variant rates 9% and 12%
- Identify that you receive 100$ every month based on rate
Simplify Price
PV = C *(1-(1_(𝟏+𝒊)^𝒏 ))/ I = F/(1+i)
-To use the annuity formula for an annual bond
- This depends on a sum of Pvs
- Mathematical formula used for bond payment
Bond Valuation
- Compute using formulas that discount rates and years to maturity
- Solution to follow equation. Compute
- Coupon bonds and years to maturity
- Use annual rates
Adjusting the PV Formula for payments
- Semi annual rates for bonds
- Annual interest and semiannual months
- Equation to compute price of a semi-annual bond
###Semi-annual bond calculation
Annual is split based on period Identify 6% based interest
Relationship price and maturity
- PV = ∑ 𝐶/(1 + i)t +F_ + 𝐹/(1 + 𝑖 ) This impacts yield and maturity
Rate and Bonds
- Rate will depend on YTM, yield, and coupon rates
- Coupon rates are equal at Par and below or High, with relationship to bond sells
Market impact on Prices
- Bond costs drop and rate goes higher
- Investors require higher YTM yield or rates
Visual Price impact
- Example: the graph below shows the PV of a 15-year bond paying an annual coupon of 10%, for various levels of yield to maturity
Key Bond Prices
- Changes based on Interest and Issuer markets
- Yields, rates, and quality
Terms in relation to Par Value (Price)
- Equal at Par, so P = F
- Selling below Par (or a discount) , P < F
- Selling above Par (A premium) , P >F_
YTM
- All points have a same yield
- Depends on the factors of the market
- High Rate required for investors to join
Risk Analysis
- Credit depends on if yield is higher and securities are issued
- Default risk based on issues between payments and credits
- Depending on issuer market and qualities as stated
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
