Bonds & Interest Rates - Fixed Income Fundamentals

Comprehensive vocabulary flashcards covering the fundamentals of bonds, interest rate relationships, asset classes, credit ratings, and yield curve structures based on the fixed income lecture.

Fundamental Relationship in Fixed Income

The inverse relationship between interest rates and bond prices: when interest rates rise, bond prices fall; when interest rates fall, bond prices rise.

Face Value / Par Value

The principal dollar amount of a bond that is paid back to the bondholder at maturity (e.g., $\$1{,}000$ per bond).

Coupon Rate

The stated annual interest rate on the face value of a bond (e.g., $4\% = \$40/\text{year}$ on a $\$1{,}000$ face value).

Coupon Payment

The actual dollar amount paid out to the bondholder (e.g., $\$40/\text{year}$ or $\$20$ every 6 months).

Maturity Date

The specific date on which the principal or face value of a bond is repaid to the investor.

Yield to Maturity (YTM)

The total expected rate of return on a bond if held until its maturity date, accounting for its purchase price and all remaining coupon payments.

Credit Rating

An independent assessment of an issuer's probability of default (e.g., S&P ratings such as AAA, AA, A, BBB).

Credit Spread

The difference in yield between a corporate bond and a comparable risk-free Treasury bond, reflecting compensation for credit and liquidity risk.

Basis Point (bps)

A standard unit of measure for bond yields and interest rates, equal to one-hundredth of a percentage point ($100\,\text{bps} = 1\%$).

Corporate Bonds

Debt issued by companies that pays higher interest rates than government bonds to compensate investors for default risk.

Government Bonds / Treasuries

Debt issued by the US government that is considered risk-free in practice, offering lower yields but maximum liquidity and safety.

Municipal Bonds (Munis)

Debt securities issued by state and local governments whose interest is frequently tax-exempt at the federal level.

Asset Backed Securities (ABS)

Bonds backed by pools of contractual debt assets (such as auto loans, credit card balances, student loans, and equipment leases) whose cash flows fund coupon and principal payments.

Residential Mortgage Backed Securities (RMBS)

Debt securities backed by pools of residential mortgages where homeowners' monthly mortgage payments flow directly to bondholders.

Prepayment Risk

The risk that homeowners will pay off their mortgages earlier than scheduled, disrupting expected cash flow timing for RMBS investors.

Private Credit

Privately originated debt securities not traded on public exchanges that typically provide a $1\text{--}3\%$ yield premium due to illiquidity.

Investment Grade

Bonds rated AAA, AA, A, or BBB by S&P, indicating strong creditworthiness and low probability of default.

High Yield ("Junk")

Bonds rated BB, B, CCC, and below by S&P that carry higher default risk and offer substantially higher yields.

National Association of Insurance Commissioners (NAIC)

The regulatory body that establishes insurance-specific credit rating categories to govern the quality of fixed-income assets held by insurance companies.

NAIC 1

The highest quality investment grade tier under the NAIC rating framework, corresponding to S&P ratings of AAA to A-.

NAIC 2

The second investment grade tier under the NAIC rating framework, corresponding to S&P ratings of BBB+ to BBB-.

NAIC 3

The NAIC rating category corresponding to below investment grade (high yield) securities, equivalent to S&P ratings of BB+ to BB-.

NAIC 4–6

The lowest NAIC rating categories covering debt rated B and below, representing speculative quality through default.

Yield Curve

A visual graph plotting the yields of bonds of identical credit quality against different maturities, typically ranging from 1 month to 30 years.

Normal Yield Curve

A yield curve shape where long-term bond yields exceed short-term bond yields because investors require a higher return for taking on greater duration risk.

Inverted Yield Curve

A yield curve configuration where short-term interest rates exceed long-term interest rates, commonly signaling an impending recession.