POI Conceptual Questions Ch. 13 - 16

Subordination clause of a bond is related to

Seniority of a bond

Describe a spot rate for a given maturity

The yield on a zero-coupon bond for that maturity, representing the interest rate applicable today for a single cash flow at that horizon

With regards to the properties of bond duration, holding other factors constant, a lower yield to maturity….

Increases duration because future cash flows are discounted less heavily

Describe liquidity risk in bond markets

The risk that a bond cannot be traded quickly, in large quantities, and at low cost without significantly affecting its price

What best describes the ratings of investment-grade bonds

BBB or above (BBB is lowest investment grade)

Why do investors generally prefer higher convexity, holding duration constant?

Because bond prices respond more favorably to interest rate changes, increasing more when yields fall than they decrease when yields rise by the same amount. Convexity improves asymmetry.

Describe a credit spread for corporate bonds

The difference between the yield on a corporate bond and the yield on a comparable Treasury bond, reflecting compensation for risk

What’s another term for credit spread

The default premium

With regards to yield curve models predicting recessions, the provide _____, not ______

They provide probabilities, not certainties

Describe a credit default swap (CDS)

A derivative that provides protection against default risk

What are Treasury STRIPS?

Zero-coupon securities created by separating interest and principal payments from Treasury bonds

What is a yield curve?

A graph of bond yield versus maturity or term

What does a lower coupon do to a bond’s duration?

Lower coupon increases duration

According to the Expectations Hypothesis, long-term rates reflect…

Expected future short rates

What does duration measure?

Interest rate (price) sensitivity

The short rate refers to…

The rate for a given time interval at different points in time

The term typically refers to…

The difference between yields on long-term and short-term Treasury securities

Which bond gives the investor the right to sell the bond back before maturity?

Putable bond

The spot rate is…

The interest rate prevailing today for a zero-coupon bond of a given maturity

An inverted yield curve implies…

Probable recession in the future months but far from certain

What is a pure yield curve based on?

Zero-coupon Treasury securities

What is yield to maturity (YTM)

The discount rate that makes the present value of promised cash flows equal to the bond’s price

The invoice price includes ________________, and the Excel PRICE function calculates ________________

The invoice price includes interest earned since the last payment, and the Excel PRICE function calculates the flat (quoted) price

Which bonds are most sensitive to interest rate changes?

Long-term, low-coupon bonds

What is the bond equivalent yield (BEY)?

The annualized yield based on semiannual compounding, calculated as twice the semiannual yield

Which bond gives the issuer the right to repurchase the bond before maturity?

Callable bond

A forward rate is…

An interest rate agreed upon today for a loan or bond transaction in the future

When does duration provide a good approximation of interest rate risk?

For small yield changes where the price-yield relationship is approximately linear

Holding the yield to maturity constant, describe how premium and discount bond prices change as maturity approaches

Premium bonds fall toward par, while discount bonds rise toward par