Fixed Income Markets Exam 2

The relationship between yield and maturity is referred to as the

term structure of interest rates

The graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities is known as the

yield curve

There is a problem with using the ________ _____ curve to determine the one yield at which to discount all the cash payments of any debt instrument

treasury yield

Each cash flow should be discounted at a unique ______ ____ that is applicable to the time period when the cash flow is to be received

interest rate

Because any debt instrument can be viewed as a package of ___-_______ instruments, its value should equal the value of all the component zero-coupon instruments

zero-coupon

The rate on a zero-coupon bond is called the

spot rate

A default-free theoretical spot rate curve can be constructed from the yield on Treasury securities using:

only on the run treasury issues

on the run treasury issues and selected off the run treasury issues

all treasury coupon securities and bills

treasury coupon strips

When securities used are only on the run treasury issues, a method known as ___________ is used. More complex statistical techniques are used when all Treasury coupon securities and bills are used

bootstrapping

Under certain assumptions, the market’s expectation of future interest rates can be extrapolated from the theoretical treasury spot rate curve. The resulting rate is called the

forward rate

The spot rate is related to the current

six-month spot rate and the six-month forward rates

Several theories have been proposed about the determination of the term structure:

pure expectation theory

biased expectations theory (liquidity theory and preferred habitat theory)

market segmentation theory

All the expectations theories hypothesize that the one-period forward rates represent the

market’s expectations of future actual rates

The pure expectations theory asserts that

it is the only factor

The biased expectations theories assert that

there are other factors

Traditional credit analysis involves an assessment of creditor protections set forth in the lending agreement:

the collateral available for the creditor should the borrower fail to make the required payments, and the capacity of the borrowers to fulfill its payment obligations

Covenants contained in the lending agreement set forth limitations on the borrower’s management and, as a result,

provide safeguard provisions for creditors

Although collateral analysis in important, there is a question of what “______ _______” means in the case of a reorganization if the absolute priority rule is not followed

secured position

In assessing the ability of a borrower to service its debt, credit analysts look at a myriad of financial ratios as well as qualitative factors, such as

the issuer’s business risk and corporate government risk

In assessing the ability of a borrower to service its debt, credit analysts also assess the borrower’s

business risk

corporate governance risk

financial risk

Business risk is the risk associated with operating cash flows, and an analysis of it begins with an understanding of a

company’s business model

In assessing business risk, some of the main factors considered are

industry characteristics and trends

the company’s market and competitive positions

management characteristics

the national political and regulatory environment

Corporate governance risk involves assessing

the ownership structure of the corporation

the practices followed by management

policies for financial disclosure

Assessing financial risk involves traditional ratio analysis and other factors affecting the firm’s financing. The more important financial ratios analyzed are

interest coverage

leverage

cash flow

net assets

working capital

Financial ratios in isolation have limited usefulness. A benchmark is needed to assess a company’s

creditworthiness