Podcast
Questions and Answers
Which credit rating indicates the highest level of creditworthiness?
Which credit rating indicates the highest level of creditworthiness?
What is the impact of decreasing short term interest rates on bond prices?
What is the impact of decreasing short term interest rates on bond prices?
What does a high credit default swap (CDS) spread indicate?
What does a high credit default swap (CDS) spread indicate?
Which of the following rating categories represents a non-investment grade security?
Which of the following rating categories represents a non-investment grade security?
Signup and view all the answers
What happens when the spread between corporate investment grade bond yields and 10-year government bond yields increases?
What happens when the spread between corporate investment grade bond yields and 10-year government bond yields increases?
Signup and view all the answers
What happens to bond yields when the government increases short term interest rates?
What happens to bond yields when the government increases short term interest rates?
Signup and view all the answers
How do mortgage rates typically relate to government bond yields?
How do mortgage rates typically relate to government bond yields?
Signup and view all the answers
Which factors primarily affect the yield on long-term bonds?
Which factors primarily affect the yield on long-term bonds?
Signup and view all the answers
When might a country with high credit risk require a bailout?
When might a country with high credit risk require a bailout?
Signup and view all the answers
What results from increased consumer spending when purchasing homes?
What results from increased consumer spending when purchasing homes?
Signup and view all the answers
Which rating signifies substantial risk and could be classified as highly speculative?
Which rating signifies substantial risk and could be classified as highly speculative?
Signup and view all the answers
In the context of credit ratings, what does the term 'high grade' refer to?
In the context of credit ratings, what does the term 'high grade' refer to?
Signup and view all the answers
Which term describes the situation when corporate bonds begin to outperform government bonds?
Which term describes the situation when corporate bonds begin to outperform government bonds?
Signup and view all the answers
What is a primary influence on the left side of the yield curve?
What is a primary influence on the left side of the yield curve?
Signup and view all the answers
What economic phenomena could regularly synchronize worldwide due to yield curve movements?
What economic phenomena could regularly synchronize worldwide due to yield curve movements?
Signup and view all the answers
Which is NOT a factor influencing long-term bond yields?
Which is NOT a factor influencing long-term bond yields?
Signup and view all the answers
What happens to bond yield and bond value when debt to GDP increases?
What happens to bond yield and bond value when debt to GDP increases?
Signup and view all the answers
What strategy did Japan employ in 2017 to maintain low bond yields despite a high debt to GDP ratio?
What strategy did Japan employ in 2017 to maintain low bond yields despite a high debt to GDP ratio?
Signup and view all the answers
How is deficit to GDP calculated?
How is deficit to GDP calculated?
Signup and view all the answers
Why do short-term bonds generally have lower yields than long-term bonds?
Why do short-term bonds generally have lower yields than long-term bonds?
Signup and view all the answers
What effect can frequent issuance of short-term bonds have on a government's creditworthiness?
What effect can frequent issuance of short-term bonds have on a government's creditworthiness?
Signup and view all the answers
How does the popularity of the US dollar influence its bond yields?
How does the popularity of the US dollar influence its bond yields?
Signup and view all the answers
What does a credit rating of AAA suggest about a government's bonds?
What does a credit rating of AAA suggest about a government's bonds?
Signup and view all the answers
Which country tends to utilize more short-term bonds compared to long-term bonds?
Which country tends to utilize more short-term bonds compared to long-term bonds?
Signup and view all the answers
Which credit rating indicates a bond is considered low risk and investment grade?
Which credit rating indicates a bond is considered low risk and investment grade?
Signup and view all the answers
What is the primary purpose of debt refinancing for the US?
What is the primary purpose of debt refinancing for the US?
Signup and view all the answers
Which of the following is a characteristic of uninvestment grade bonds?
Which of the following is a characteristic of uninvestment grade bonds?
Signup and view all the answers
What was the credit rating of Enron before its bankruptcy in 2001?
What was the credit rating of Enron before its bankruptcy in 2001?
Signup and view all the answers
Why is a short-term borrowing strategy risky for countries with low creditworthiness?
Why is a short-term borrowing strategy risky for countries with low creditworthiness?
Signup and view all the answers
What do credit ratings by agencies such as S&P and Moody's indicate?
What do credit ratings by agencies such as S&P and Moody's indicate?
Signup and view all the answers
How do corporate bond ratings compare to government bond ratings?
How do corporate bond ratings compare to government bond ratings?
Signup and view all the answers
What was the effect of a green rating from credit agencies?
What was the effect of a green rating from credit agencies?
Signup and view all the answers
How does the time until a bond's maturity generally affect its price responsiveness to interest rate changes?
How does the time until a bond's maturity generally affect its price responsiveness to interest rate changes?
Signup and view all the answers
What happens to the current yield of a bond when its market value changes?
What happens to the current yield of a bond when its market value changes?
Signup and view all the answers
What is a key assumption made by YTM regarding coupon payments?
What is a key assumption made by YTM regarding coupon payments?
Signup and view all the answers
As a bond approaches its maturity date, what primarily influences whether its price increases or decreases?
As a bond approaches its maturity date, what primarily influences whether its price increases or decreases?
Signup and view all the answers
Why might a buyer avoid paying a premium price for a bond that is nearing maturity?
Why might a buyer avoid paying a premium price for a bond that is nearing maturity?
Signup and view all the answers
What does a current yield curve typically represent as bonds approach maturity?
What does a current yield curve typically represent as bonds approach maturity?
Signup and view all the answers
What can cause a bond that is currently a discount bond to be sold at a premium later?
What can cause a bond that is currently a discount bond to be sold at a premium later?
Signup and view all the answers
What is true about the bond market compared to other financial markets?
What is true about the bond market compared to other financial markets?
Signup and view all the answers
What is the formula for calculating Current Yield?
What is the formula for calculating Current Yield?
Signup and view all the answers
What does the Yield to Maturity represent?
What does the Yield to Maturity represent?
Signup and view all the answers
If a bond has a coupon rate of 5% and a nominal value of $100, what is the amount paid in coupon payments per year?
If a bond has a coupon rate of 5% and a nominal value of $100, what is the amount paid in coupon payments per year?
Signup and view all the answers
How is Current Yield described in terms of holding the bond?
How is Current Yield described in terms of holding the bond?
Signup and view all the answers
Which of the following statements is true regarding how yield is usually expressed?
Which of the following statements is true regarding how yield is usually expressed?
Signup and view all the answers
What happens to Current Yield each time the bond is resold?
What happens to Current Yield each time the bond is resold?
Signup and view all the answers
What is the main difference between Current Yield and Yield to Maturity?
What is the main difference between Current Yield and Yield to Maturity?
Signup and view all the answers
What is the significance of using 'guesswork' in calculating Yield to Maturity?
What is the significance of using 'guesswork' in calculating Yield to Maturity?
Signup and view all the answers
Study Notes
Fixed Income Investments (Bonds)
- Fixed income is a fancy term for borrowing and lending
- Bonds are tradable IOUs (I Owe You)
- Bonds involve a promise to pay regular fixed amounts of money (coupon or interest) and a large amount (principal) at a final date (redemption date)
- The world bond market is worth approximately $101 trillion, greater than the world GDP ($79 trillion) and the world stock market ($69 trillion)
- The US bond market is the largest in the world, comprising about 20% of the global bond market ($22 trillion)
- Bonds are categorized by ownership: corporate bonds (owned by companies) and government bonds (owned by governments)
The Fixed Income Market
- Governments use bond sales to fund things like wars, security, and justice projects
- When government spending exceeds income, it uses borrowing to cover the deficit
- This deficit financing is not necessarily bad news
- Bond markets allow governments to borrow from other countries
Government Bonds
- The government bond market (Sovereign Debt Market) is the largest portion of the bond market
- The US government bond market is worth $14 trillion, while the corporate bond market is worth $8 trillion
- The Bank of England was established in 1694 to finance the British Royal Navy
Government Debt
- Government debt isn't always negative; how it's managed matters more
- The US has a high amount of debt, estimated around $16 trillion as of 2008
- Other countries buy US bonds to protect their currency if the value decreases
- US bonds are the safest and most liquid financial asset due to the strength of the US dollar as the world's reserve currency, and the US's strong credit ratings
Bonds and US Dollar
- Bonds, like the foreign exchange (FX) market, are denominated in US dollars
- Countries use each other's bond investments to finance budget deficits or during periods of inflation and exchange rate fear
- US government bonds are sought after during exchange rate fear
Corporate Bonds
- Companies issue corporate bonds for two main reasons
- Debt is tax deductible
- Bonds serve as long-term financing
Bond Yield
- Bond yield is the current market interest rate on a bond
- It depends on supply and demand
- The initial interest rate (coupon rate) might not stay the same throughout the bond's life
- The bond's market value fluctuates with demand and supply, but the repayment amounts are fixed
- Bond Yield ≠ Fixed Price ≠ Fixed Interest rate
Bond Yield and Market Value
- When the yield is higher than the coupon rate, the market value of the bond is less than the face value
- When the yield is lower than the coupon rate, the market value of the bond is higher than the face value
- Bond yield and market value move inversely
Bond Valuation
- If a bond is issued during the middle of a year, the coupon amount needs to be adjusted/pro-rated
- The present value of the principal and periodic coupon payments is used to determine the bond's market value
Present Value of Principal and Interest
- The market value of a bond equals the present value of principal repayment, plus the present value of interest payments
Bond Valuation Drivers
- Credit Risks: The probability of the bond issuer defaulting on its obligations. Default is predicted to affect future returns negatively and this discourages investors to invest in the bond, thus reducing the value of the bond
- Macroeconomic Environment: Short-term interest rates and Inflation
Short-term Interest Rates
- Government actions to adjust short-term interest rates affect bond prices and thus yield. Increasing rates reduce bond prices, whilst lowering rates increases them.
Inflation
- Inflation usually shows excess money supply, and increases the interest rates to reduce the money supply and increases bond yield values
The Output Gap
- The difference between the potential output of an economy (ideal production) and its actual output
- A positive output gap signals inflation
- A negative output gap signals deflation
Statements about Interest Rate Policies
- Issuing statements about future interest rate policy changes can affect the market before the change actually occurs
Short-term Interest Rate Estimates
- To address inflation (+ output gap), Central Banks increase short-term interest rates. This is to make borrowing expensive and encourages cash deposit with the government, subsequently decreasing money supply
The Yield Curve and Why it Matters
- A graphical representation of yield to maturity (YTM) against the maturity period for a country's government and corporate bonds
- Generally slopes upwards (longer tenure, higher yield)
- Changes in the short-term side of the yield curve can have a knock-on effect on the larger economy (corporate & consumer impact)
Corporate Impact (of Yield Curve)
- Corporate borrowing costs are affected by changes in government borrowing costs. A wider yield curve spread indicates that corporate bonds are underperforming
- A smaller spread indicates corporate bonds are outperforming
Consumer Impact (of Yield Curve)
- Mortgage rates typically follow government bond yields
- This affects the cost of borrowing for homeowners and the level of housing market activity
Global Impact (of Yield Curve)
- Bond yields in different countries tend to move similarly, influenced by factors like investments, debt, and aid
Credit Risk Indicators (Measures)
- Credit rating agencies (S&P, Moody's, Fitch, DBRS) assess the creditworthiness of bonds, both corporate and government
- Investment-grade bonds have high ratings (e.g., AAA, AA); junk bonds carry low ratings
- Bonds with fluctuating ratings are less reliable
Credit Default Swaps (CDS)
- CDS measures the inherent probability of bond issuer default. It is more reliable than frequent credit ratings due to observable nature and earlier notification.
Bond Valuation Drivers (Continued)
- Short-term interest rates: Changes in short-term interest rates directly impact bond prices.
- Inflation: Inflation reduces the purchasing power of future bond payments
The Output Gap and Central Bank Toolkits
Central banks measure inflation and the output gap to assess the economic climate and use relevant policy tools to manage the situation
Investors' Predictions and The Yield Curve
- Investors' expectations about inflation and interest rates influence their decisions regarding bond purchases and sales, which can affect a country's yield curve.
- An inverted yield curve (short-term yields greater than long-term yields) is frequently associated with economic recession
- A flattened or steep yield curve indicates varying economic conditions
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
Related Documents
Description
Explore the world of fixed income investments, focusing on bonds as tradable IOUs. This quiz covers the significance of the bond market, the role of governments in bond sales, and the categorization of different types of bonds. Test your understanding of how the bond market operates and its impact on global finance.
