Managing Bond Portfolios and Interest Rate Risk

Vocabulary flashcards covering key concepts from the 'Managing Bond Portfolios. Interest Rate Risk' lecture, including bond classifications, market structures, risk measurements, and portfolio management strategies.

Bonds

Often called fixed-income securities, they promise either a fixed stream of income or one determined by a specified formula, representing debt securities as claims on a periodic income stream.

Bond Issuers

Entities that issue bonds, including government (Treasury Bonds and Notes), local government (municipal bonds), financial institutions, companies (corporate bonds), and international institutions (e.g., World Bank).

Coupon bond

A bond that pays a fixed stream of income (coupon payments) at regular intervals until maturity.

Zero-coupon bond

A bond that does not pay periodic interest but is issued at a discount and repays its face value at maturity.

Fixed-rate bonds

Bonds that pay a predetermined, unchanging interest rate over their lifetime.

Floating-rate bonds

Bonds with interest rates that adjust periodically based on a specified formula or benchmark.

Bullet bond

A bond that repays the entire principal (face value) at maturity in a single payment.

Annuity bond

A bond structured to make equal total payments (principal + interest) over its life, similar to an annuity.

Discount Treasury Bills (DKJ)

Hungarian government securities with maturity less than one year, denominated in HUF, issued at a discount with no interest paid, and face value repaid at redemption.

Hungarian Government Bond (MÁK)

Hungarian government securities with a maturity longer than one year, denominated in HUF, that are interest-bearing (fixed or floating rate bond).

Investment grade bonds

Bonds with high credit ratings, indicating a lower risk of default.

Junk bonds

Also known as high-yield bonds, these are non-investment grade bonds with lower credit ratings, implying a higher risk of default but potentially higher returns.

Callable Bonds

Bonds that give the issuer the option to extend or retire the bond at the call date.

Puttable Bonds

Bonds that give the bondholder the option to extend or reclaim principal.

Convertible Bonds

Bonds that give bondholders an option to exchange each bond for a specified number of shares of common stock of the firm.

Primary Market (Bonds)

The market where securities are issued and sold to the public for the first time, often through auctions for government securities.

Primary Dealers

Financial institutions with exclusive rights to participate in government securities auctions and obligations to maintain minimum capital, purchase securities, and quote prices.

Secondary Market (Bonds)

The market for trading bonds that have already been issued, involving primary dealers, banks, investment funds, and insurance companies, through exchanges or over-the-counter platforms.

Interest Rate Risk (Bonds)

The risk of bond prices fluctuating due to changes in interest rates or the yield curve, noting an inverse relationship between bond prices and yields.

Duration (Macaulay's Duration)

The weighted average of the times to each coupon or principal payment of a bond, serving as a key determinant of interest rate risk, expressed in years.

Modified Duration (D*)

The absolute value of the bond price's semi-elasticity with respect to the interest rate level, indicating how much the bond price changes if the yield curve shifts by one percentage point.

First-Order Approximation (Bond Price Change)

An estimation of bond price changes using the formula ∆𝑃 = −𝐷∗ ∙ 𝑃 ∙ ∆𝑟, where a higher duration implies a greater price change per unit change in yields.

Convexity (Bonds)

A measure of the curvature of a bond's price-yield relationship, used for second-order approximation to improve price change estimates when yield curve shifts are larger or non-parallel.

Immunization (Bond Portfolio Management)

A bond portfolio management strategy where the portfolio is constructed to have zero duration, making it independent of interest rate movements, though it usually requires dynamic rebalancing.

Bond Indices

Benchmarks used to assess the performance of bond portfolios, such as the MAX index family and BMX indices for Hungarian government bonds, or the Bloomberg Barclays US Aggregate Bond Index.