Fixed Income Instruments Overview
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Questions and Answers

What does the yield curve allow investors to determine about bonds?

  • The duration of a bond's cash flow
  • The relative pricing of other bonds of different classes
  • The implied return from a given investment (correct)
  • The fixed cash flows of all bonds

    • Which of the following statements about floating rate bonds is true?

  • The coupon value is influenced by market interest rates (correct)
  • You know the full cash flow schedule upon purchase
  • They have a variable maturity date
  • The coupon payments are fixed for the life of the bond

    • How is the price of a floating rate bond generally affected at reset dates?

  • It decreases below par value
  • It will generally be close to par value (correct)
  • It begins to reflect future interest rate movements
  • It remains unaffected by market interest rates

    • What does the term 'interest-rate risk' primarily refer to for floating rate bonds?

    <p>The risk related to the next coupon payment</p> Signup and view all the answers

    Which part of the cash flow for a floating rate bond changes based on market conditions?

    <p>The variable part of the coupon</p> Signup and view all the answers

    What primarily determines the term spread between long-term and short-term interest rates?

    <p>Expected future inflation and economic growth</p> Signup and view all the answers

    How is the duration of a portfolio containing a spread and a zero-spread floater calculated?

    <p>By using the weighted sum of each component's duration</p> Signup and view all the answers

    What condition would cause the yield curve to be nearly flat?

    <p>Investors/borrowers show no concern about the maturity of bonds</p> Signup and view all the answers

    What does an upward-sloping yield curve generally indicate regarding future interest rates?

    <p>Future interest rates are expected to be higher than current rates</p> Signup and view all the answers

    What does the yield to maturity (YTM) of a bond represent?

    <p>The expected fixed rate of return if the bond is held to maturity</p> Signup and view all the answers

    What does the dirty price of a bond include?

    <p>The full price including accrued interest from the last coupon</p> Signup and view all the answers

    What role do government bonds play in constructing a reliable yield curve?

    <p>They are highly liquid and available in various forms</p> Signup and view all the answers

    Which statement is true about the clean price of a bond?

    <p>It is the price quoted in the market, excluding accrued interest</p> Signup and view all the answers

    Under what conditions can YTM be considered accurate?

    <p>If the bond is held until maturity and no payments default</p> Signup and view all the answers

    What is needed to compute the present value of cash flows for a bond?

    <p>The cost of capital or discount rate to apply</p> Signup and view all the answers

    What is a bull-spread strategy primarily used for?

    <p>To profit from a substantial increase in stock price</p> Signup and view all the answers

    In which scenario would creating a short straddle be most profitable?

    <p>When expecting stable stock prices</p> Signup and view all the answers

    What effect do increasing interest rates have on the prices of call and put options?

    <p>Call option prices increase while put option prices decrease</p> Signup and view all the answers

    What is the primary purpose of hedging with a put option?

    <p>To protect against downside risk of an asset</p> Signup and view all the answers

    Which strategy involves buying both a call and a put with the same strike price?

    <p>Straddle</p> Signup and view all the answers

    In an interest rate swap, what type of payments does party A make to party B?

    <p>Fixed rate payments</p> Signup and view all the answers

    What is the primary risk associated with the payments in an interest rate swap after the first payment date?

    <p>Uncertainty due to changing LIBOR rates</p> Signup and view all the answers

    In a currency rate swap, what does party A do?

    <p>Makes payments in one currency to party B</p> Signup and view all the answers

    What characterizes a commodity swap?

    <p>Payments depend on the price of an underlying commodity</p> Signup and view all the answers

    What is a feature of European options compared to American options?

    <p>They can only be exercised at expiration</p> Signup and view all the answers

    Which of the following statements about the payoff of an option is true?

    <p>The payoff corresponds to the underlying asset's price at expiration</p> Signup and view all the answers

    What is the right granted by a call option?

    <p>To purchase the underlying asset at a predetermined price</p> Signup and view all the answers

    What differentiates an American option from a European option?

    <p>American options allow for exercise on or before expiration</p> Signup and view all the answers

    What type of securities are backed by loans such as auto loans and student loans?

    <p>Asset-Backed Securities (ABS)</p> Signup and view all the answers

    Which of the following describes a Collateralized Debt Obligation (CDO)?

    <p>A structured product pooling various types of debt into tranches</p> Signup and view all the answers

    What is the main characteristic of preferred stocks?

    <p>They provide fixed dividends and predictable income streams.</p> Signup and view all the answers

    Which type of bonds offers protection against inflation by adjusting principal and interest payments?

    <p>Inflation-Linked Bonds</p> Signup and view all the answers

    What best describes Floating Rate Notes (FRNs)?

    <p>Bonds that have variable interest rates tied to benchmarks.</p> Signup and view all the answers

    What differentiates Eurobonds from Foreign Bonds?

    <p>Eurobonds are issued in a currency other than the country of issue.</p> Signup and view all the answers

    What is the nature of Zero-Coupon Bonds?

    <p>They are issued at a discount and mature at par.</p> Signup and view all the answers

    Which of the following best describes Convertible Bonds?

    <p>Bonds that can be converted into fixed amounts of company's equity shares.</p> Signup and view all the answers

    Study Notes

    Fixed Income Instruments

    • Fixed income refers to investments that pay fixed interest or dividends until maturity, returning the principal at maturity.
    • Examples include bonds (government, corporate, municipal), Treasury bills, certificates of deposit (CDs), and fixed-rate preferred stocks.
    • Fixed income security markets help determine interest rates and prices of other securities.

    Characteristics of Fixed Income Instruments

    • Regular Income: Investors receive fixed or variable payments at regular intervals (monthly, semi-annually, annually).
    • Principal Repayment: The instrument's face value is returned at maturity.
    • Lower Risk: Compared to equities, fixed-income investments generally offer less risk due to steady cash flows and priority in liquidation.
    • Credit Risk: The risk that the issuer may default on its obligations. Higher credit quality (e.g., government bonds) typically means lower risk but also lower returns.

    Risks Associated with Fixed Income

    • Interest Rate Risk: The value of a fixed-income investment can decline as interest rates rise, impacting the price of existing bonds.
    • Credit Risk: The risk that the issuer will default on interest payments or fail to return the principal.
    • Inflation Risk: Inflation can decrease the purchasing power of future interest payments and principal repayments.
    • Reinvestment Risk: Reinvesting interest or principal payments may result in lower returns compared to the initial investment's yield.

    Active and Passive Management

    • Active Management: Outperforming the market using strategies like duration management, credit selection, and yield curve positioning.
    • Passive Management: Replicating the performance of a fixed-income index, emphasizing low cost and broad exposure.

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    UE 2 - Capital Markets and Financial Instruments PDF

    Description

    Explore the fundamentals of fixed income instruments, including their characteristics, types, and the risks involved. This quiz covers various aspects such as regular income, principal repayment, and the differences in risk profiles between these investments and equities.

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