CISI (CMP) Securities > Chapter 2: Asset Classes D > Flashcards

Chapter 2: Asset Classes D Flashcards

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1
Q

What are ordinary and preference shares known as in the US?

A

Common stock, and preferred stock.

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2
Q

What are redeemable shares?

A

Offered to shareholders, company can purchase them back at any time.

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3
Q

What are preference shares?

A

Less risk than ordinary, rank above in bankruptcy
Generally do not have voting rights
Receive fixed dividend

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4
Q

What are preference shares sometimes known as?

A

Hybrid securities, as they can have characteristics similar to bonds

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5
Q

What order is preference, ordinary and debtholders paid out in during bankruptcy?

A

Debt
Pref
Ord

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6
Q

How are dividends decided?

A

Proposed by directors
Ratified by shareholders during AGM

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7
Q

What can a proxy do?

A

Vote on behalf of shareholders

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8
Q

What is the nominal value of ordinary shares?

A

Represents the minimum amount that a company must receive from subscribers upon issue of the shares.

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9
Q

What are the types of preference shares? (5)

A

Cumulative
Participating
Redeemable
Convertible
Zero Coupon
shares can have any combination of these

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10
Q

What is a cumulative preference share?

A

Paid dividend and any unpaid dividends from previous years
(how can dividends be unpaid??)

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11
Q

What is a participating preference share?

A

Preference shares have fixed dividend, participating gives them the opportunity to participate in higher distributions and other liquidation events.

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12
Q

What are redeemable preference shares?

A

Company can buy back the shares at agreed price in future.
Liability for the company, counts as debt.

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13
Q

What is a convertible preference share?

A

Shareholder has right, not obligation to convert to ordinary shares
Can provide exposure to upside

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14
Q

What is a zero coupon preference share?

A

Pay no dividend, but they can redeem at a price above what they are issued

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15
Q

What does SOFR stand for?

A

Secured Overnight Financing Rate

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16
Q

What are bonds that are linked to interest rates called?

A

Floating-rate notes (FRNs)

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17
Q

What are bonds that are linked to inflation called?

A

“Index-linked”

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18
Q

What is a yield?

A

The measure of the percentage return that an investment provides.

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19
Q

What are the 3 ways to calculate a bond yield?

A

Flat yield
Gross redemption yield (GRY)
Net redemption yield (NRY)

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20
Q

What is flat yield also known as?

A

Interest or running yield

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21
Q

How do you calculate the flat yield?

A

annual coupon / price

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22
Q

How can flat yield be used to see the relationship between interest rates and prices?

A

As interest rates increase, investors want an equivalent yield on bonds.
As they have an inverse relationship, and the coupon is fixed - the price must fall and vice versa

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23
Q

What is Gross Redemption Yield sometimes known as?

A

Yield to Maturity (YTM)

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24
Q

What does Gross Redemption Yield not take into consideration?

A

Taxation

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25
How is the GRY calculated?
Takes into account yield including redemption amount.
26
What is the NRY?
Net Redemption Yield
27
What does NRY take into account that GRY does not?
Taxation
28
What does modified duration measure?
Volatility
29
What is modified duration?
Expected change in price, given a change in interest rates. Usually measured percent change per 1% change in the interest rate
30
What is the formula for modified duration?
(modified duration / 100) * price * percentage change don't forget it is inversely proportional
31
What is a convertible bond?
Give the holder the right to covert bond into ordinary shares
32
When would the investor choose to convert bonds into ordinary shares?
If the value of the shares exceeds the redemption value of the bond
33
Why would convertible bonds trade at a premium to their share value?
They provide downside protection in the form of redemption value if shares do not perform well, and interest payments Similar to an option
34
How is conversion premium percentage calculated?
Premium / share conversion value
35
What is the conversion ratio calculation?
nominal value / conversion price of shares E.g. £100 nominal convert to shares at £5 each = 20 shares
36
What are the 3 downsides of flat yield?
Ignores redemption flow, incomplete picture of returns Ignores timing of cash flow, time value of money overlooked If it is a FRN, the return will vary
37
What is the flat price sometimes known as?
Clean price
38
How often do most bonds pay out?
Semi-annually
39
When is the bond price equal to the flat price?
On settlement dates where the interest is paid
40
What do you use to calculate the bond price between payment dates?
Using accrued interest
41
What is the formula for accrued interest?
Coupon payment * (number of days since last payment / number of days between payments)
42
What is the dirty price?
Clean price + accrued interest
43
What is the flat price?
What is listed in bond tables for prices
44
How are months treated with ACT/360 or ACT/365 calculation?
Each month treated normally, regardless of leap year (Feb is 28 not 29)
45
In which calculation method are leap years taken into account?
ACT/ACT
46
What is a spread in bond markets?
The difference between two yields
47
How many basis points in 1%?
100
48
What are the 3 main bonds benchmarks?
Gov bond yields Swap rates (exchanging FRN for fixed market) Published reference rates e.g. LIBOR, now SOFR
49
How does the risk of a bond usually affect the spread over benchmark?
Higher risk is higher spread
50
How is the yield curve plotted?
Government bonds of different maturities Yield on y axis, time to maturity on x axis Yield curve is the line of best fit
51
What does a conventional yield curve look like?
Increasing, lower risk in short dated so will be a lower yield Short dated have more liquidity
52
When would a yield curve invert?
When investors expect significant interest rate reductions in future Often interpreted as a sign of economic slowdown as reducing rates means there is a low demand for credit
53
Which countries (4) and Central Banks (1) have attempted negative yields?
Denmark, Sweden, Switzerland, Japan European Central Bank (ECB)
54
What is the intention behind negative yields?
Discourage saving, to encourage lending and spending to boost the economy
55
Why haven't negative interest rates been widely adopted?
Bank depositors would switch to cash, which affects central bank profitability and control Impact long term investments Encourages "yield-chasing", investment in riskier bonds / other speculative investments
56
How can you compare nominal yields and real yields?
Compare yields on inflation linked instruments to normal E.g. index-linked GILTs. US Treasury Inflation Protected Securities (TIPS)
57
How would central bank concern about inflation affect medium and long dated govvy bonds?
Cause a fall, as they would increase short-term rates to counteract inflationary pressures
58
How can the time value of money be illustrated?
Taking account the prevailing rate if interest $100 received in 1 year in 5% rate environment is worth 100/1.05 95.24 This is called the present value
59
What is the calculation for present value of a future payment? receivable after n years, interest rate = r
1/(1+r)^n = discount rate
60
What nominal are governments bonds usually quoted on?
100 units of the currency's nominal value e.g. $100
61
What is the ex-dividend period?
A period where a bond is dealt without entitlement to the impending coupon payment
62
What is the ex-dividend period for most gilts?
7 days
63
What is the cum-dividend period?
Period where bonds are dealt with coupon entitlement
64
What are ILGs?
Index-Linked Gilts
65
What examples of indexes do linked bonds follow? (2)
RPI - Retail Price Index CPI - Consumer Price Index
66
Is the principal repayment affected in index-linked bonds?
Yes
67
How do US TIPS achieve index linking?
Adjusting the principal outstanding on the bond using CPI Coupon is based on the fixed coupon set at issue multiplied by the adjusted principal At maturity investor is paid the greater of the adjusted principal and the original principal
68
What index is being used for ILGs?
RPI Industry convention, in prospectus for older gilts
69
What is a deflation floor?
Some government bonds guarantee that the redemption payment will not be less than the original value US, France
70
Does the UK government offer a deflation floor?
No
71
When was the eight month trailing RPI changed to 3 months for Index linked gilts?
2005
72
How do you calculate the real interest rate?
[(1 + nominal interest rate) / (1 + inflation rate)] - 1
73
What was the short-term interest rate at the start of the 80's in response to high inflation in the 70's in the US/UK?
20%
74
When was the RPI changed to the CPI?
2003
75
What is the CPI-based inflation target?
2%
76
What does the PPI measure?
Inflationary pressures at an earlier stage in the production process e.g. raw materials and other inputs
77
What does PPI stand for?
Producer prices indices
78
What is the main UK measures of inflation?
CPI - 2%
79
Who sets the CPI-based inflation target?
BoE Monetary Policy Committee MPC
80
What are ZCBs?
Zero Coupon Bonds
81
What does STRIPs stand for?
Separate Trading of Registered Interest and Principal of Securities
82
What does a STRIP involve?
Trading the interest and principal of a GILT separately
83
How many separate securities can a 2 year GILT be stripped into?
5 4 x coupon 1 x redemption
84
Who can strip eligible gilts in the UK?
GEMMs - gilt-edged market makers BoE
85
What does GEMMs stand for
Gilt-edged market makers
86
What is the purpose of STRIPs?
Allows investors to precisely match liabilities E.g. coupon comes in when they need to pay something
87
What is reconstitution?
Exchanging STRIPS for a conventional GILT, with the DMO as counterparty
88
What is the maturity of; T-bonds T-notes T-bills
T-bonds >10 years T-notes 2-10 years T-bills <1 year
89
What is the different maturity names of Gilts?
0-7 years - "short-dated" 7-15 years - "medium-dated" >15 years - "long dated"
90
What is BRICS?
Main emerging markets Brazil, Russia, India, China and South Africa
91
How can corporate debt be divided? 2 sections
Money borrowed from banks Money borrowed from investors (bonds)
92
What is less risky, debt finance or equity finance?
Debt finance, has to be paid before dividends/buy-backs
93
What are the two ways of securing debt?
Fixed charge - Debt carries charge over a single company asset Floating charge - Debt secured against a group of company assets
94
What are asset-backed securities?
Bonds that are backed by a particular pool of assets
95
What does ABSs stand for?
Asset-backed securities
96
What are some examples of ABSs?
Mortgage loans, credit card receivables, car loans
97
What does securitisation stand for?
Packaging financial instruments together to create a security
98
What does MBSs stand for?
Mortgage backed securities
99
How do firms such as Fannie Mae and Freddie Mac operate?
Government firms that buy qualifying mortgage loans and securitise them and issue bonds to investors
100
How can ABSs and MBSs be subdivided?
Into tranches, with each tranche having a specific priority in relation to interest and principal payments.
101
Why do payment dates differ across ABSs?
Different products in each one, e.g. credit card, mortgage
102
What does SPV stand for?
Special Purpose Vehicle
103
How is a SPV structured?
It is a trust, and the originator of the assets (e.g. bank granting loans) sells the loans to the SPV and the SPV issues the asset-backed bonds
104
What is the purpose of an SPV? (2)
Separate entity to the originator of the assets, assets leave the originators financial statements and replaced by cash. As SPV is stand-alone entity, it remains intact even if originator goes bankrupt - increases creditworthiness of the ABSs.
105
What is the process of assets being exchanged for cash in an originators balance sheet?
Off-balance-sheet arangement
106
What is the bankruptcy protection of an SPV sometimes known as?
"bankruptcy-remote"
107
What is a covered bond?
Asset-backed bond where no SPV is created, the originators assets "cover" the bondholder
108
What can an originator do in times of crisis? E.g. 08
Transfer the troubled assets back to its balance sheet to become covered bonds
109
How do European covered bonds differ?
Usually kept on balance sheet of the originator rather than transferred to an SPV.
110
What is a secured debt transaction known as in the UK?
Debenture
111
What is a secured loan known as in the US?
ABS
112
What does a debenture refer to in the US?
Loan agreement with no security
113
What happens when a corporation issues secured debt to a large number of people?
A trustee is appointed
114
What are the 4 main UK trustee roles?
Note trustee Security trustee Share trustee Successor trustee
115
What is a Note trustee?
Appointed to represent the interests of holders of the securities Provide guidance to the issuer
116
What is a Security trustee?
For issues secured by securities, the trustee is charged in favour of the trustee for the benefit of the secured parties. Documents will dictate how it is paid out
117
What is a Share trustee?
Holds the shares in an issuing SPV in order to ensure off-balance-sheet treatment for the originator Sometimes SPVs are domiciled off-shore
118
What is a Successor trustee?
Provided for banks who need to resign due to conflicts of interest or capacity issues
119
What is the benefit of a trustee?
Single entity that acts on behalf of shareholders, rather than a many individual actions. Organised action. Reduction in costs
120
What is a representation of the interests of the bondholders?
Trustee assigned to represent the interests of bondholders, makes security more marketable paid for by issuer
121
What will a corporate trustee do?
Make sure that the issuer is sticking to all its covenants from it's issuance documents e.g. debt ratios, bonds issued
122
What are the 3 tiers of debt?
Senior Sub-ordinated Mezzanine
123
What is senior debt?
Paid first, usually has strict covenants Can be secured, has the lowest interest rate
124
What is subordinated debt?
2nd in line, higher interest rate less stringent requirements
125
What is mezzanine debt?
High risk subordinated debt, ranks behind unsecured debt. High interest rate Interest can be skipped and added to the principal outstanding Can include warrants/options so lender can get equity returns
126
What is payment in kind, a.k.a PIK?
Interest that is deferred until principal repayment
127
Who is paid first between unsecured debtholders and shareholders?
Unsecured debtholders, lenders always paid firsty
128
What is guaranteed debt?
Guarantee provided by someone other than the issuer. Usually parent company
129
What is the benefit of convertible bonds to the issuer?
Lower cost of debt and possibility of avoiding repayment if lender converts
130
What did the LIBOR represent?
The average rate at which banks offer loans to other banks
131
Why was the LIBOR administration changed to the FCA?
Banks were manipulating the rate
132
What are the two new rates in the UK and US?
SONIA - Sterling Overnight Index Average SOFR - Secured Overnight Financing Rate
133
What to FRNs usually add to benchmark rates?
A fixed margin, e.g. 175 bps - 1.75%
134
What are the 3 prominent rating agencies?
Standard and Poor's Moody's Fitch Ratings
135
Why has regulatory oversight of credit rating agencies increased?
Rated junk bonds highly during the 2008 GFC
136
What are the two categories of bond rating?
Investment grade Non-investment grade/speculative
137
How can issues be credit-enhanced to gain a higher credit rating?
Insurance scheme that pays out if issuer not able to
138
What is gross vs net interest
Gross - pre-tax Net - post-tax
139
What are the two prime examples of money market instruments?
T-bills, Commercial paper (CP)
140
What are the risks in investing in cash?
Credit risk Inflation risk
141
How to T-bills produce return?
No coupon, discount to repayment
142
Why do issuers take care to not miss CP payments?
Even delay by one day can lead to bankruptcy proceedings
143
What is the most common CP term?
3 months
144
What are the two methods of issuing CP?
Direct to buy-and-hold investors, e.g. money market funds Sell paper to a dealer who sells the paper in the market
145
What is it called when companies issue paper direct to investors?
Direct paper
146
How much would issuers save issuing direct paper?
5 bps (0.05%)
147
What does rolling form of debt mean?
New issues fund the retirement of old issues
148
What is the main risk for CP?
Refinancing/rollover risk Companies are not able to reissue CP
149
What is a repo?
Sale and repurchase agreement It involves an initial sale of a financial instrument and, at the same time, a contractual agreement that the seller will subsequently buy back the same financial instrument for a specified price at a set future date.
150
Why would a participant enter into a repo transaction?
Lower the cost of borrowing by offering government securities as collateral
151
Why would a participant enter a reverse-repo transaction?
Loaning out excess cash with bonds as collateral
152
When may a market-making firm enter a reverse repo?
When it has sold bonds short, and needs to locate bonds in order to fulfill its settlement obligations
153
How does the DMO assist in the smooth running of GILT markets?
Standing order repo facility. Allows GEMMs to enter into reverse repo transactions to cover short positions created by market making
154
How do GEMMs access the standing repo facility and what is the minimum amount?
Sign documentation, request any amount above £5m nominal
155
What is a repo equivalent to?
Short-term secured loan
156
What is a Eurobond?
Bonds that are issued and sold outside of their home country currency does not need to be the euro
157
What currency does a Eurobond need to be?
Any, just different to the home currency from the place where they are issued e.g. UK Eurobond cannot be pound sterling
158
What do Eurobonds allow corporations to do?
Issue debt without being restricted to their own domestic market Provide investors access to invest in markets/currencies outside their home countries
159
What are the 3 steps to issuing a Eurobond?
1. Issuer appoints lead manager (investment bank), underwrites and establishes details 2. Lead manager establishes a syndicate 3. Syndicate distributes bonds to its client base
160
In what form are Eurobonds issued?
Bearer form
161
How often are Eurobond coupons paid?
1x / year
162
What is it called when a bearer bond is deposited in a CSD?
Immobilised
163
What CSDs are Eurobonds settled through? (2)
Euroclear & Clearstream
164
What is a GDR?
Global Depository Receipt
165
How do depository banks assist in DRs?
Issuer will supply the ords to the depository bank Depository bank will then sell DRs to external investors Cash proceeds are then provided to the issuer
166
What is grey market trading in terms of DRs?
When DR is created, Depository Bank receives confirmation that they will receive the shares in future Even if they don't have the shares yet they can create and sell DRs This can be done for 3 months before the purchase of the ORDs
167
How are DRs registered?
The ORDs are in the name of the depository bank DRs are transferable as bearer securities
168
How do dividends work with DRs?
Depository Bank acts as an intermediary Will receive proceeds as registered owner of the ORDs Distribute to DR holders
169
What are NVDRs?
Non-voting DRs e.g. Thailand Form of capital control
170
How can an investor sell their DRs?
To another investor as DRs, or as underlying shares in home market Latter involves cancelling the DR with Depository Bank. ORDs are then re-issued. Can be done due to lack of liquidity.
171
What do warrants allow investors to do?
Purchase shares in a company at a fixed price over a period
172
Why would a company issue warrants?
Receive income from selling warrant Receive income if investor purchases shares with the warrant
173
What is a covered warrant?
Issued by firms, rather than the companies Call warrants and put warrants Traded on the LSE
174
What is the conversion premium of warrants?
(warrant price + exercise price) - share price
175
What is it called when the conversion premium is negative?
Conversion discount
176
What are the two types of real estate?
Residential and Commercial
177
Who is responsible for repairs in commercial tenancies
Tenant
178
What is the diversification benefit of property?
Usually low correlation with traditional and alternative asset classes
179
What is the liquidity downside of real estate mutual funds?
Property funds can bring in measures to limit outflows in times of crisis E.g. 12-month moratoria on redemptions
180
What is the main tax feature of REITs?
Prevents double taxation
181
What is double taxation?
If investor held company shares, company pays corporation tax and the investor would be liable to any tax on dividends
182
How do REITs prevent double taxation?
REITs do not pay corporation tax
183
What are the (2) tax-exempt conditions for REITs?
Must contain at least 3 single rental properties, with none being >40% of value REIT must distribute at least 90% of rental profits by dividend
184
Why might an investor be able to invest in through a REIT but not individually?
Commercial property
185
What risks do REITs alleviate?
Lack of diversification Liquidity risk
186
How is a REIT fund structured?
Closed-ended fund Shares traded similar to company shares
187
What is an open ended fund?
Collective funds utilising investors money to buy portfolios of investments Investors are given units in the fund
188
What are the two types of FX transaction?
Spot Forward
189
What is a spot and when is it settled?
Immediate conversion of currency at agreed price Within 2 working days
190
How do FX dealers profit?
Between the bid and the ask, spread
191
What is a forward transaction?
Deal agreed for a future date at a set exchange rate
192
What two camps do FX users fall into?
International trade Planning for future cash flows with forwards to hedge currency movements Speculation Investors making predictions on future moves
193
How are FX pairs quoted?
base currency / counter currency E.g. USD/GBP Base is always quoted in one unit
194
What is the counter currency sometimes known as?
Quote currency
195
How do market markets / dealers quote currencies?
Using a bid.ask E.g. EUR/USD, the quote might be 0.9937 / 39. So if you want to buy €100,000, then you will need to pay the higher of the two prices and deliver $99,390; if you want to sell €100,000, then you get the lower of the two prices and receive $99,370.
196
What is a cross rate?
A currency rate that does not include the USD E.g. GBP/JPY
197
What is the exception to the cross rate terminology?
GBP/EUR
198
Why would the cross rate be of interest to companies?
If they do a lot of trade with another country and receive payment in that currency
199
What is a stepped bond
A bond that has a coupon that increases over time
200
How would a GBP USD spot quote bid ask be quoted?
GBP/USD spot rate 1.555 - 1.1645
201
How would a forward be quoted?
three-month forward 1.00-0.97c pm
202
What does the pm stand for in a forward?
Premium
203
What is the premium quoted in?
cents/pennies
204
What does dis stand for in a forward?
Discount
205
What is rational pricing?
Asset prices will reflect the arbitrage-free price of asset, as any deviation is arbitraged away
206
What does interest rate parity say should be true for future and spot markets?
Spot and future prices incorporate any interest rate differentials between the two. If not then there will be opportunity for risk-free arbitrage return.
207
How would you calculate the forward rate for GBP/USD?
spot rate * [(1+US$ short-term interest rate) / (1 + UK£ short-term interest rate)]
208
What do you need to remember when doing forward rate calculations?
The interest rate is calculated on an annual basis, e.g. for 3 month forward, need to divide by 4.
209
As per what agreement were exchange rates fixed?
1944 Bretton Woods
210
When did fixed exchange rates end?
1970's Abandonment of convertibility into Gold, Aug 1971
211
What does PPP stand for?
Purchasing Power Parity
212
What does PPP refer to?
Purchasing Power Parity is the theory that currencies should have equal purchasing power.
213
What is the most widely traded currency pair, per BIS?
USD/EUR
214
What is a carry trade in FX?
Borrowing of funds where interest is low, and purchasing relatively high yield government bonds.
215
What is the definition of a CIS? (3)
* invests in transferable securities * is publicly marketed, and * is open-ended.
216
What are some examples of unregulated CISs?
Golf courses in Mexico, Wine in France etc...
217
What is an open-ended fund?
One that can issue and redeem shares in the scheme at any time
218
What are some examples of open ended funds around the world? (3)
US Mutual Funds UK's open-ended investment companies (OEICs) Europe’s sociétés d’investissement à capital variable (SICAVs)
219
What is a closed-ended fund?
Set number of shares are issued, and then it is traded on the secondary market Investment trusts/companies
220
What are the two major forms of open ended funds?
Unit trusts OEICs
221
What is a unit trust?
Professionally managed collective investment fund Investors buy units, which represent a specified fraction
222
What is an AUT?
Authorised unit trust, allowed to be marketed to the investing public.
223
What is the role of a trustee in an OEIC?
Protect the interests of the unitholders Essentially beneficiaries
224
What is the role of a manager in an OEIC?
Marketing the trust Managing the assets Maintaining record of units
225
How it the NAV calculated? (3 parts)
* the value of the trust’s listed investments at mid-market prices * the value of its unlisted investments at the directors’ valuation, and * cash and other net current assets
226
What can closed ended funds do that OEICs can't? (3)
Invest in private companies Provide venture capital Borrow money
227
What is tracking impact?
The effect that these index funds have on the market, e.g. when a new company is added to SP500
228
What are ETNs, Exchange Traded Notes?
Senior debt noes issued by banks
229
How can retail investors access Private Equity?
Through closed ended funds
230
What are structured products?
Investments which provide a return based on the performance of an underlying asset, usually index
231
What is the structured product time range?
18 months - 7 years
232
Do structured deposits and investments benefit from FSCS?
No, only deposits do - investments do now
233
What are the two types of structured investment?
Capital at risk (SCaRPs, Structured Capital at Risk Products) Principal-protected investments
234
What is the soft floor?
Where an investor in a SCaRP will get most/all of their money back if an index does not fall by a certain amount
235
What is a precipice bond?
Pay a set level of income over a set period Precipice is that if a reference index falls by more than a certain level the capital will suffer an equivalent loss
236
How are structured products made up?
Will be different asset classes. E.g. a bond (protects investor principal) and a derivative (higher returns)
237
What does a callable structured product mean?
The product can mature early if it reaches a certain level
238
What is it called when structured products pay-off the underlying stays within a certain range?
range accruals pay-off
239
What is an averaging value structured product?
Return is based on the average value of the underlying over a time period Can help protect against last short term dips when selling
240
What is a lookback feature in structured products?
Can realise the returns based on the highest percentage rise of the underlying
241
What are cash or nothing pay-offs?
The return is either paid or not based on in a particular event occurs, e.g. above x price
242
What is quantity adjusting (Quantos) structured prodducts?
Protect against currency risk
243
What is the yield curve a visual representation of?
Term structure of interest rates, rates from the same issuer across different maturities
244
Why would a investors be willing to get a lower yield for longer term bonds? (Inverted yield curve)
They believe interest rates will be lower then
245
Which countries pay annual coupons?
France / Germany
246
Which countries have T+2 settlement on bonds?
France / Germany
247
What are the the names for German bond maturity?
Bund - >10 year Bobl - 5 years Schatz - Up to 2 years
248
What two categories can Equities be divided into?
Ordinary and Preference shares
249
What is nominal value
The amount that the borrower will pay back to the holder on maturity / the capital payment the holder receives at redemption
250
What is the coupon
Expressed as an annual % of the nominal value. UK pay this semi-annually
251
What are floating rate notes (FRNs)
Bonds that state the coupon by reference to a published interest rate, such as the SOFR and reset the coupon paid when the published interest rate changes Trade near par (Price=NV)
252
Who issues government bonds in US and UK
Bureau of Fiscal Service in US Debt Management Office (DMO) in UK
253
What is the ex-dividend period and how long is it for gilts
Because of possible ownership changes before the coupon payment date, the period prior to each coupon date when a bond is dealt without entitlement to the impending coupon payment is called the ex-dividend period (despite its a bond) For most gilts its 7 working days prior to the coupon payment date For the remainder of time, the bond is described as trading cum-dividend
254
What is the risk free rate
the rate on government bonds and short-term debts, because of the low chance that the government will default on its loans
255
Describe the 2 types of government bond
Index linked- Bonds where coupon payments and principal (redemption amount) are adjusted in line with a published index of price inflation (RPI/CPI). Lower yield Conventional- Fixed coupons, fixed maturity, eroded by inflation
256
Give examples of US and UK index-linked bonds
UK Index-linked gilts (ILGs) US TIPS
257
What is the effect of inflation on index-linked bonds
If CPI positive, there is inflation and principal increases, if CPI negative there is deflation and principal decreases
258
What happens to index-linked bonds in times of zero inflation
In a period of zero inflation, index-linked bonds will pay the nominal coupon rate with no adjustment and simply pay back the nominal value at maturity.
259
What happens to index-linked bonds in times of deflation
In periods of deflation (negative inflation, with prices persistently falling), some sovereign index-linked bonds (eg, in the US and France) have a ‘deflation floor’, with the issuer guaranteeing that the redemption payment will not be less than the original par value. However, there is no deflation floor for the UK’s index-linked gilts, where the possibility exists of returning less than the nominal value at redemption
260
Real interest rate formula
Real interest rate = [(1 + nominal interest rate) / (1 + inflation rate)] – 1
261
CPI
Based on an EU-wide formula that was originally called the HICP, allowing direct comparison of the inflation rate in the UK against that in the rest of Europe. CPI at 2% is the current target for the BoE’s Monetary Policy Committee (MPC).
262
RPI
An average measure of change in the prices of goods and services using basket of 300 goods. Once published, it is never revised.
263
PPI
– this is based on measuring inflation further up the supply chain at the wholesale level, including ‘factory gate’ inflation
264
What are Separate Trading of Registered Interest and Principal of Securities (STRIPS)
Stripping a bond involves trading the interest (each individual coupon) and the principal (the nominal value) separately. Each individual strip forms the equivalent of a ZCB. Each strip will trade at a discount to its face value, with the size of the discount being determined by prevailing interest rates and time.
265
What are zero coupon bonds (ZCBs)
- Pay no interest - Bought at discount and redeemed at nominal value
266
Who are the permitted parties who can strip gilts
- Only gilt-edged market makers: - GEMMS - HM Treasury - Bank of England
267
What is the advantage of STRIPS
investors can precisely match their liabilities few worries about the risk that the issuer of the bonds will default
268
How many zero coupon bonds can a 7-year strippable gilt be stripped into
(7*2)(semi annual coupon payments)+1(final capital payment)=15
269
What is dedication
Where the investor matches the maturity of cash flows to liabilities, simply done through ZCBs. STRIPS facilitate this as act as ZCBs
270
What is reinvestment risk
Where the investor may not receive a required rate of return when reinvesting coupon payments (possibly because interest rate has fallen), therefore can't meet liabilities
271
Which US and UK bonds can be stripped
US T-notes and bonds, including TIPS. In the UK, gilts that have been designated as strippable by the Debt Management Office (DMO)
272
What is reconstitution
‘Reconstitution’ is, effectively, exchanging STRIPS for a conventional gilt, with the UK DMO as the counterparty to the deal
273
US T-Bills 1. Coupon frequency? 2. Maturity? 3. Settlement period?
1. No coupon paid 2. Less than one year 3. Trade date
274
US T-notes 1. Coupon frequency? 2. Maturity? 3. Settlement period?
1. Semi-annual 2. 2-10 years 3. T+1
275
USA T Bonds 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1. Registered 2. Semi-annual 3. >10 4. T+1
276
UK (Gilts) 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1. Registered 2. Semi annal 3. Short:<7, Med:7-15, Long:>15 4. T+1
277
Japan (JGBs) 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1. Registered or bearer 2. Semi annual 3. 2-40 years (Long is most common:10 Superlong:20) 4. T+1
278
France Bonds 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1.Bearer 2. Annual 3. OATS: 2-50 4. T+2
279
Germany T Bonds 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1. Bearer 2. Annual 3. Schatz: Up to 2 Bobl: 5 Bund: 10-30 4. T+2
280
What are the types of corporate bonds
Secured debts securities- Bonds secured by assets of company (named asset e.g. property) - consists of fixed charge and floating charge over assets Unsecured debt securities
281
Describe the 2 ways of issuing secured debt
Fixed charge over assets– The debt carries a charge over a particular company asset, eg, a building or land. A mortgage charge is a type of fixed charge. Floating charge over assets- the debt is secured against a group of the company’s assets (e.g. plant and machinery) ; in the event of default, a floating charge crystallises over the available assets at that point
282
Another word for unsecured debt
Loanstock
283
What is the meaning of debenture in the UK vs US
UK: A secured bond (with fixed charge) US: Unsecured bond In US they call secured debt asset backed security (ABS)
284
What is meant be secured debt and give examples
Bonds secured by assets of company (named asset e.g. property) - consists of fixed charge and floating charge over assets Eg. ABS, MBS, Covered Bonds
285
What is meant by unsecured debt and give examples
Has typical life of 7-30 years Convertible bonds Exchangeable bonds Guaranteed bonds Floating rate notes (FRNs) Payment in kind notes (PIK)
286
What are Asset-Backed Securities (ABS)
Asset-backed securities (ABSs) are bonds that are backed by a particular pool of assets sch as property, loans, credit card receivables
287
What are Mortgage-Backed Securities (MBS)
Mortgage-backed securities (MBSs) are one example of ABSs. They are created from mortgage loans made by financial institutions like banks and building societies. MBSs are bonds that are created when a group of mortgage loans are packaged (or pooled) for sale to investors. As the underlying mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal.
288
Who are major issuers of MBS
The MBS market began in the US, where the majority of issues are made (or guaranteed) by an agency of the US government. The Government National Mortgage Association (commonly referred to as Ginnie Mae), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are the major issuers
289
Difference between ABS and covered bonds
Both are same thing (secured debt) but have different names depending on who owns If the pool of assets is owned by the originator eg the bank who lent out the mortgage, its called a covered bond If the pool of assets is owned by a special purpose vehicle (SPV), its called an Asset Backed Security (SPV)
290
What is the purpose of a SPV (Special Purpose Vehicle)
ABSs often utilise a special purpose vehicle (SPV) in order to lessen the default risk that investors face when investing in the securities. This SPV is often a trust, and the originator of the assets, such as the bank granting the mortgage loans, sells the loans to the SPV and the SPV issues the asset-backed bonds.
291
Benefits of SPV
OFF BALANCE SHEET ARRANGEMENT: The SPV is a separate entity = assets leave the originator’s financial statements to be replaced by cash. BANKRUPTCY REMOTE : The SPV is a stand-alone entity, so, if the originator of the assets suffers bankruptcy, the SPV still remains intact with the pool of assets available to service the bonds.
292
Purpose of a trust deed and benefits
When a corporation either in the UK or US issues secured debt to a large number of persons, it is invariably the case that a trustee will be appointed. A trust deed empowers the trustee alone to act on behalf of debenture holders - ensures organized action and parity of treatment through a single entity (instead of individual holders dealing separately) But costly
293
Different trustees
...
294
What is mezzanine debt
The mezzanine level of debt will rank below other forms of debt but above the equity in a liquidation. For example, a payment in kind note (PIK) To reflect the risk, the interest on mezzanine debt tends to be much higher than subordinated debt. Indeed, some or all of the interest might not be paid in cash and is added to the principal outstanding instead. This rolled up interest is often described as ‘payment in kind’ interest, or PIK. Sometimes the mezzanine debt will also include warrants or options so that the lender can participate in equity returns
295
What is senior debt
As the name suggests, this debt ranks above all other debt and equity capital in the business. It will be repaid before any of the other tiers of lender receive anything. . It will have the lowest interest rate of all the tiers since, from the lender’s perspective, it is more secure
296
What is subordinated debt
Again, as suggested by the name, this debt ranks behind senior debt – it is subordinated to senior debt – in the event that the company is liquidated
297
List order of debt seniority in event of liquidation
Paid first: (Liquidator) 1. Fixed charge holders (bond secured against named asset in company) 2. Preferential creditors eg employees 3. Floating charge holders (bond secured against pool of assets) 4. Unsecured creditors (unsecured debt/loanstock) - guaranteed bonds and convertible bonds rank alongside other unsecured debt here 5. MEZZANINE DEBT ( Subordinated loan stock eg PIK) --------------------------------------------------------------------- 6. Preference shareholders (fixed nominal value only except participating shareholders) 7. Ordinary shareholders if anything left
298
What are exchangeable bonds
Converts into stock of another, usually subsidiary of the issuer (exchange for shares of third party company)
299
What are guaranteed bonds
Another company guarantees payment
300
What are payment in kind notes (PIK)
Zero coupon bonds that are issued at a substantial discount to their face value
301
What is LIBOR
LIBOR. LIBORs reflect the average rates at which banks in London offer loans to other banks. Benchmark for interbank borrowing
302
What is SONIA
Sterling Overnight Index Average (SONIA) in UK: Published by the Bank of England and based on the actual overnight rates banks borrow money
303
What is SOFR
Secured Overnight Financing Rate (SOFR) in the US: Published by the Federal Reserve and based on actual overnight Treasury repo market
304
What is a eurobond and what type of ownership does it have and how is it traded
Bond issued in eurocurrency (any currency other than the currency of the market its issused) Bearer document Traded OTC or some exchange-traded
305
Who regulates Eurobonds
Regulated by ICMA
306
Eurobonds Coupon Day count convention for accrued interest Settlement
Gross annual coupon 30/60 T+2 settlement
307
What are stepped bonds
Coupons increase over the life of the bond
308
What is immobilization
As bearer documents, Eurobonds are often held in depositaries like Euroclear or Clearstream - can still be traded if held in depositary
309
A bond which has just defaulted on a coupon payment would be rated as by Standard and Poor's and Fitch as:
D
310
According to the credit ratings agency Moody's what credit rating would be issued to a bond in default?
C
311
Which asset classes can be broken into tranches offering different levels of risk and return?
Mortgage-backed securities Collateralised debt obligations
312
Interest rates on index-linked gilts are linked to:
Retail price index
313
Credit enhancements are:
Tools used by an issuer to enable bonds to be more highly-rated
314
Who issues JGBs
They are issued by the Government of Japan
315
Patrick observes that the effective price per share from a convertible bond is lower than the current market price of the underlying shares. How can he profit from this observation?
Buy the convertible and sell the underlying shares
316
Why would a company prefer to issue a convertible bond rather than issue shares to finance a takeover?
To benefit from lower initial servicing costs
317
What type of coupon does a vanilla convertible bond usually pay?
Fixed
318
What is the system for reporting eurobond trades?
TRAX
319
What is nominal value
The amount that the borrower will pay back to the holder on maturity / the capital payment the holder receives at redemption
320
What is the coupon
Expressed as an annual % of the nominal value. UK pay this semi-annually
321
What are floating rate notes (FRNs)
Bonds that state the coupon by reference to a published interest rate, such as the SOFR and reset the coupon paid when the published interest rate changes Trade near par (Price=NV)
322
Who issues government bonds in US and UK
Bureau of Fiscal Service in US Debt Management Office (DMO) in UK
323
What is the ex-dividend period and how long is it for gilts
Because of possible ownership changes before the coupon payment date, the period prior to each coupon date when a bond is dealt without entitlement to the impending coupon payment is called the ex-dividend period (despite its a bond) For most gilts its 7 working days prior to the coupon payment date For the remainder of time, the bond is described as trading cum-dividend
324
What is the risk free rate
..
325
Describe the 2 types of government bond
Index linked- Bonds where coupon payments and principal (redemption amount) are adjusted in line with a published index of price inflation (RPI/CPI). Lower yield Conventional- Fixed coupons, fixed maturity, eroded by inflation
326
Give examples of US and UK index-linked bonds
UK Index-linked gilts (ILGs) US TIPS
327
What is the effect of inflation on index-linked bonds
If CPI positive, there is inflation and principal increases, if CPI negative there is deflation and principal decreases
328
What happens to index-linked bonds in times of zero inflation
In a period of zero inflation, index-linked bonds will pay the nominal coupon rate with no adjustment and simply pay back the nominal value at maturity.
329
What happens to index-linked bonds in times of deflation
In periods of deflation (negative inflation, with prices persistently falling), some sovereign index-linked bonds (eg, in the US and France) have a ‘deflation floor’, with the issuer guaranteeing that the redemption payment will not be less than the original par value. However, there is no deflation floor for the UK’s index-linked gilts, where the possibility exists of returning less than the nominal value at redemption
330
Real interest rate formula
Real interest rate = [(1 + nominal interest rate) / (1 + inflation rate)] – 1
331
CPI
Based on an EU-wide formula that was originally called the HICP, allowing direct comparison of the inflation rate in the UK against that in the rest of Europe. CPI at 2% is the current target for the BoE’s Monetary Policy Committee (MPC).
332
RPI
An average measure of change in the prices of goods and services using basket of 300 goods. Once published, it is never revised.
333
PPI
– this is based on measuring inflation further up the supply chain at the wholesale level, including ‘factory gate’ inflation
334
What are Separate Trading of Registered Interest and Principal of Securities (STRIPS)
Stripping a bond involves trading the interest (each individual coupon) and the principal (the nominal value) separately. Each individual strip forms the equivalent of a ZCB. Each strip will trade at a discount to its face value, with the size of the discount being determined by prevailing interest rates and time.
335
What are zero coupon bonds (ZCBs)
- Pay no interest - Bought at discount and redeemed at nominal value
336
Who are the permitted parties who can strip gilts
- Only gilt-edged market makers: - GEMMS - HM Treasury - Bank of England
337
What is the advantage of STRIPS
The key advantage of STRIPS is that investors can precisely match their liabilities, removing any reinvestment risk. STRIPS can meet the liabilities of the investor precisely, removing any reinvestment risk that is normally faced when covering liabilities with coupon-paying bonds. Furthermore, investors in government bond STRIPS have few worries about the risk that the issuer of the bonds will default – for example, liabilities of the US and UK governments are generally considered to be virtually free of any default risk (also known as credit risk
338
How many zero coupon bonds can a 7-year strippable gilt be stripped into
(7*2)(semi annual coupon payments)+1(final capital payment)=15
339
What is dedication
Where the investor matches the maturity of cash flows to liabilities, simply done through ZCBs. STRIPS facilitate this as act as ZCBs
340
What is reinvestment risk
Where the investor may not receive a required rate of return when reinvesting coupon payments (possibly because interest rate has fallen), therefore can't meet liabilities
341
Which US and UK bonds can be stripped
STRIPS markets have been developed in US Treasuries and in the UK gilts market. US financial institutions are able to create STRIPS from US T-notes and bonds, including TIPS. In the UK, only those gilts that have been designated as strippable by the Debt Management Office (DMO) are eligible for the STRIPS market, not all gilts. Those gilts that are stripped have separate registered entries for each of the individual cash flows that enable different owners to hold each individual strip, and facilitate the trading of the individual STRIPS.
342
What is reconstitution
‘Reconstitution’ is, effectively, exchanging STRIPS for a conventional gilt, with the UK DMO as the counterparty to the deal
343
US T-Bills 1. Coupon frequency? 2. Maturity? 3. Settlement period?
1. No coupon paid 2. Less than one year 3. Trade date
344
US T-notes 1. Coupon frequency? 2. Maturity? 3. Settlement period?
1. Semi-annual 2. 2-10 years 3. T+1
345
USA T Bonds 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1. Registered 2. Semi-annual 3. >10 4. T+1
346
UK (Gilts) 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1. Registered 2. Semi annal 3. Short:<7, Med:7-15, Long:>15 4. T+1
347
Japan (JGBs) 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1. Registered or bearer 2. Semi annual 3. 2-40 years (Long is most common:10 Superlong:20) 4. T+1
348
France Bonds 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1.Bearer 2. Annual 3. OATS: 2-50 4. T+2
349
Germany T Bonds 1. Legal form 2. Coupon frequency 3. Maturity 4. Settlement period
1. Bearer 2. Annual 3. Schatz: Up to 2 Bobl: 5 Bund: 10-30 4. T+2
350
What are the types of corporate bonds
Secured debts securities- Bonds secured by assets of company (named asset e.g. property) - consists of fixed charge and floating charge over assets Unsecured debt securities
351
Describe the 2 ways of issuing secured debt
Fixed charge over assets– The debt carries a charge over a particular company asset, eg, a building or land. A mortgage charge is a type of fixed charge. Floating charge over assets- the debt is secured against a group of the company’s assets (e.g. plant and machinery) ; in the event of default, a floating charge crystallises over the available assets at that point
352
Another word for unsecured debt
Loanstock
353
What is the meaning of debenture in the UK vs US
UK: A secured bond (with fixed charge) US: Unsecured bond In US they call secured debt asset backed security (ABS)
354
What is meant be secured debt and give examples
Bonds secured by assets of company (named asset e.g. property) - consists of fixed charge and floating charge over assets Eg. ABS, MBS, Covered Bonds
355
What is meant by unsecured debt and give examples
Has typical life of 7-30 years Convertible bonds Exchangeable bonds Guaranteed bonds Floating rate notes (FRNs) Payment in kind notes (PIK)
356
What are Asset-Backed Securities (ABS)
Asset-backed securities (ABSs) are bonds that are backed by a particular pool of assets sch as property, loans, credit card receivables
357
What are Mortgage-Backed Securities (MBS)
Mortgage-backed securities (MBSs) are one example of ABSs. They are created from mortgage loans made by financial institutions like banks and building societies. MBSs are bonds that are created when a group of mortgage loans are packaged (or pooled) for sale to investors. As the underlying mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal.
358
Who are major issuers of MBS
The MBS market began in the US, where the majority of issues are made (or guaranteed) by an agency of the US government. The Government National Mortgage Association (commonly referred to as Ginnie Mae), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are the major issuers
359
Difference between ABS and covered bonds
Both are same thing (secured debt) but have different names depending on who owns If the pool of assets is owned by the originator eg the bank who lent out the mortgage, its called a covered bond If the pool of assets is owned by a special purpose vehicle (SPV), its called an Asset Backed Security (SPV)
360
What is the purpose of a SPV (Special Purpose Vehicle)
ABSs often utilise a special purpose vehicle (SPV) in order to lessen the default risk that investors face when investing in the securities. This SPV is often a trust, and the originator of the assets, such as the bank granting the mortgage loans, sells the loans to the SPV and the SPV issues the asset-backed bonds.
361
Benefits of SPV
The SPV is a separate entity from the originator of the assets, so the assets leave the originator’s financial statements to be replaced by the cash from the SPV. This is often described as an offbalance-sheet arrangement because the assets have left the originator’s balance sheet The SPV is a stand-alone entity, so, if the originator of the assets suffers bankruptcy, the SPV still remains intact with the pool of assets available to service the bonds. This is often described as bankruptcy-remote and enhances the creditworthiness of ABSs, potentially giving them a higher rating than the originator of the assets.
362
Purpose of a trust deed and benefits
When a corporation either in the UK or US issues secured debt to a large number of persons, it is invariably the case that a trustee will be appointed. A trust deed empowers the trustee alone to act on behalf of debenture holders - ensures organized action and parity of treatment through a single entity (instead of individual holders dealing separately) But costly
363
Different trustees
...
364
What is mezzanine debt
The mezzanine level of debt will rank below other forms of debt but above the equity in a liquidation. For example, a payment in kind note (PIK) To reflect the risk, the interest on mezzanine debt tends to be much higher than subordinated debt. Indeed, some or all of the interest might not be paid in cash and is added to the principal outstanding instead. This rolled up interest is often described as ‘payment in kind’ interest, or PIK. Sometimes the mezzanine debt will also include warrants or options so that the lender can participate in equity returns
365
What is senior debt
As the name suggests, this debt ranks above all other debt and equity capital in the business. It will be repaid before any of the other tiers of lender receive anything. . It will have the lowest interest rate of all the tiers since, from the lender’s perspective, it is more secure
366
What is subordinated debt
Again, as suggested by the name, this debt ranks behind senior debt – it is subordinated to senior debt – in the event that the company is liquidated
367
List order of debt seniority in event of liquidation
Paid first: (Liquidator) 1. Fixed charge holders (bond secured against named asset in company) 2. Preferential creditors eg employees 3. Floating charge holders (bond secured against pool of assets) 4. Unsecured creditors (unsecured debt/loanstock) - guaranteed bonds and convertible bonds rank alongside other unsecured debt here 5. MEZZANINE DEBT ( Subordinated loan stock eg PIK) --------------------------------------------------------------------- 6. Preference shareholders (fixed nominal value only except participating shareholders) 7. Ordinary shareholders if anything left
368
What are exchangeable bonds
Converts into stock of another, usually subsidiary of the issuer (exchange for shares of third party company)
369
What are guaranteed bonds
Another company guarantees payment
370
What are payment in kind notes (PIK)
Zero coupon bonds that are issued at a substantial discount to their face value
371
What is LIBOR
LIBOR. LIBORs reflect the average rates at which banks in London offer loans to other banks. Benchmark for interbank borrowing
372
What is SONIA
Sterling Overnight Index Average (SONIA) in UK: Published by the Bank of England and based on the actual overnight rates banks borrow money
373
What is SOFR
Secured Overnight Financing Rate (SOFR) in the US: Published by the Federal Reserve and based on actual overnight Treasury repo market
374
What is a eurobond and what type of ownership does it have and how is it traded
Bond issued in eurocurrency (any currency other than the currency of the market its issused) Bearer document Traded OTC or some exchange-traded
375
Who regulates Eurobonds
Regulated by ICMA
376
Eurobonds Coupon Day count convention for accrued interest Settlement
Gross annual coupon 30/60 T+2 settlement
377
What are stepped bonds
Coupons increase over the life of the bond
378
What is immobilization
As bearer documents, Eurobonds are often held in depositaries like Euroclear or Clearstream - can still be traded if held in depositary
379
Who has Baa rating when others are BBB
Monody’s BBB is last grade to be speculative Below that is BB Moodys have smaller ratings if 123 while others are +\-
380
When trading in the UK government bond market and cash bargains which of the following statements is TRUE?
The cash settlement will take place following the acquisition of the bargain and by the end of the next business day This is a long way round of making sure you know Gilts settle T+1.
381
All of the following are true of convertibles except:
The issuer has the right to redeem the bond early if it is in its best interests to do so A convertible bond allows the buyer to convert into a pre-determined number of shares. It is, effectively, a 'straight' or 'vanilla' bond combined with an option to buy shares. Option A describes a CALLABLE bond, i.e. one that may be redeemed early by the issuer.
382
A bond which has just defaulted on a coupon payment would be rated as by Standard and Poor's and Fitch as:
D
383
According to the credit ratings agency Moody's what credit rating would be issued to a bond in default?
C
384
Which of the following asset classes can be broken into tranches offering different levels of risk and return?
Mortgage-backed securities Collateralised debt obligations
385
Interest rates on index-linked gilts are linked to:
Retail price index
386
Credit enhancements are:
Tools used by an issuer to enable bonds to be more highly-rated
387
Who issues JGBs
They are issued by the Government of Japan
388
Which of the following about stripped government bonds are true?
They are zero coupon They are tradable
389
Which of the following is not true of overseas government bonds?
The correct answer is: A - Bobls are bonds with a life of 10 years or less
390
Which of the following is LEAST likely about Eurobonds?
Most bonds are quoted clean but will settle dirty, all the other statements are true. TRUE: TRADES ARE MATCHED VIA TRAX SYSTEM
391
Patrick observes that the effective price per share from a convertible bond is lower than the current market price of the underlying shares. How can he profit from this observation?
Buy the convertible and sell the underlying shares
392
Why would a company prefer to issue a convertible bond rather than issue shares to finance a takeover?
To benefit from lower initial servicing costs
393
A company could issue bonds in order to satisfy the needs of investors that wish to invest in it, with the coupon rate and maturity set according to market demand. This is an example of which of the following?
Medium-term notes
394
What type of coupon does a vanilla convertible bond usually pay?
Fixed
395
Which one of the following is the system for reporting eurobond trades?
TRAX
396
Flat yield formula
Gross annual coupon/market price x 100%
397
Drawbacks of flat yield
- Time value of money overlooked - Ignores redemption flows - Not applicable to floating rate
398
Other names for flat yield
Interest yield Running Yield Simple Yield
399
Gross Redemption Yield (GRY) aka Yield to Maturity (YTM) formula
GRY = FY% + (Gross Profit/Loss at redemption)divided by number of years/market price x 100% Careful with +/- with profit and loss!!!!
400
What is the Net Redemption Yield (NRY)
Considers impact of tax on YTM by applying income tax to coupon
401
What happens if bond price is higher than the nominal value
Coupon > Flat yield> Gross redemption Yield
402
What happens if bond price is lower than nominal value
Coupon< Flat Yield< Gross Redemption Yield
403
What is meant by modified duration
Measure of volatility - approximate % change in a bond's price for a 1% change in interest rates Higher modified duration = more volatile Interest rates rise---> Bond prices fall and yields rise
404
If a government bond is priced at $95.84, and its modified duration is 1.02, what is the effect on the price after an increase in interest rates by one percentage point?
If interest rates rise by one percentage point, the bond’s price will fall by 1.02 / 100 x $95.84 = $0.98. If interest rates rise by one half of a percentage point, the bond’s price will fall by 1.02 / 100 x $95.84 x 0.5 = $0.49
405
Features of more volatile bonds
- Lower coupon bond more volatile to a change in interest rates than higher coupon bond - Longer dated bond more responsive than shorter dated bond
406
What are convertible bonds
Convertible bonds give the holder of the bond the right, but not the obligation, to convert the bond into a predetermined number of ordinary shares of the issuer. They trade at a premium due to downside protection and potential gains if share price rises
407
Conversion ratio formula
Nominal value / conversion price of shares The number of shares that each £100 of nominal value of bonds can convert into
408
Conversion Premium Calculation
Price of bond - share value of conversion choice _______________________________________ Share value of conversion choice x100
409
What is accrued interest and give formula
The interest that has been earned, but not paid Accrued interest = Coupon payment x Number of days between payments ______________________________________ Number of days in payment period
410
Difference between dirty vs clean price
Dirty price = clean price + accrued interest.
411
Cum coupon period vs Ex coupon period
In cum coupon period, seller sells bond at higher price to reflect the coupon payment they would have been entitled to as they have held it for a few months since last coupon payment. In ex coupon period, seller discounts price as buyer missing out on a few days of interest- here dirty price
412
What is the ex-coupon period for a UK gilt
7 business days
413
Explain ACT/360 day count convention
ACT/360 (days per month, days per year) – each month is treated normally and the year is assumed to be 360 days, eg, the period from 1 February 2024 to 1 April 2024 is considered to be 59 days divided by 360 (even in instances like this one, when the year is actually a leap year). ACT/360 counts are used for US Treasury bills and money market instruments
414
What is the purpose of spreads and examples
A spread is simply the difference between two yields, usually expressed in basis points, with each basis point representing 1/100 of 1%. For example, if the yield on Bond A is 5.5%, and the yield on Bond B is 5%, the spread is 5.5 – 5 = 0.5%, or 50 basis points. Spreads are used to compare instruments to one another or to a benchmark- represents risk of holding compared to comparison 1. Government securities 2. Published reference rates 3. Swap rates
415
What are swap rates
There is a very active market in exchanging floating rates for fixed rates in the so-called swaps market. The rates available on swaps are also used as benchmarks against which to judge yields.
416
What are published reference rates
LIBOR, SONIA in UK, SOFR in US
417
Describe and explain a normal yield curve
Shape is upward-sloping to the right (GRY on y axis and maturity on x axis) Shape captures how investors prefer more liquidity, so willing to accept lower yield on more liquid short-dated government bonds. Longer dated bonds have higher yields as more risk
418
Describe and explain an inverted yield curve
Downward sloping to the right. In this scenario, the yield on short term bonds is more than long term ones and occurs when interest rates expected to fall. The consequence of this is that, when investing in longer-term instruments that will be outstanding when the interest rates fall, the investor is willing to accept a lower yield. For shorter-term instruments that will not be outstanding when the interest rate falls, the investor is demanding a higher yield
419
Implications of negative yields
Negative interest rates on bank deposits would give savers an incentive to switch out of deposits into holding cash. This would see the savings move out of the banking system. If banks were to try to keep hold of the deposits by not charging the negative rates, then profitability will suffer. This could have an adverse impact on the stability of the financial system Where investors are paying to lend money. Occurring in some government bond markets, where uncertainty of economic climate creates desire to put money somewhere safe, even if you have to pay for it.
420
Present value of bond formula
Value of bond = £coupon/(1+r)^n + (£coupon+ £red value)/(1+r)^n
421
Risks of depositing cash overseas
- FX risk - Witholding tax - Exchange controls restricting repatriation
422
Most common T bill maturity
3 month
423
T Bill minimum denomination
£25,000
424
How long is CP issued in UK and US
US-up to 270 days UK- up to 1 year
425
Commercial paper features
Issued by companies with 0 coupon and discounted Unsecured short term debt, up to 1 year (typically 3 months)
426
Term repo
maturity date in excess of overnight
427
what is 1 pip
0.0001
428
What is 10 pips
0.001
429
What does GBP against USD for spot 1.5010/1.5015 mean
First means sell base - £1 buys $1.5010 Second means buy base- $1.5015 buys £1 First is bid price (lower price) which is sell price
430
How to apply pips in forward
If pips decreasing, deduct If pips increasing, add
431
Interest rate parity formula
F/S= 1+r(variable)/ 1+r(base) F= forward rate S= Spot rate
432
Which of the following currencies is used to calculate cross rates for transactions from one unusual currency to another?
US dollars
433
Consider the three following property transactions: Andy purchases a buy-to-let residential property, then leases it out. Martin leases a residential property. Sarah leases a commercial property.
Sarah will typically have a longer lease than Martin Andy is the only one generating income on the property, so is the only one exposed to void periods. The lessor of residential property (Andy) and the lessee of commercial property (Sarah) are typically responsible for the upkeep (maintenance) of the property.
434
A Japanese exporter is concerned over volatility in USD/JPY and wants to hedge receivables due from sales made in the US. A large US dollar receipt is due to come in around six months' time and the amount is known now. What would you advise the exporter to do to hedge out this risk?
Sell USD/Buy JPY six-month forward
435
What is the delivery time for a spot FX transaction after the trade date?
Two business days
436
When is settlement for eurobond transactions?
Two business days Remember also that settlement for UK corporate debt is T+2 and for gilts is T+1.
437
On the creation of an ADR, in whose name is the document registered?
An ADR, although a bearer document, is registered in the name of the depository who holds the shares.
438
Which ONE of the following statements regarding forward foreign exchange transactions is FALSE?
Non-deliverable forwards are settled at the forward rate In a non-deliverable forward, the exchange rate is set for some date in the future, but at that date the quoted currency is not exchanged. Instead, the rate is compared against the prevailing spot rate. The profit or loss is calculated as if a reverse transaction had been completed. This is the amount that is settled.
439
Which of the following is true of the dividends paid on the underlying shares of an ADR?
They are paid by the company to the depository bank
440
Interest is usually paid on Eurobonds:
Annually
441
The currencies of the United Arab Emirates and Saudi Arabia are pegged to the US Dollar. What are these examples of?
A fixed exchange rate
442
Which of the following statements is true of American depositary receipts?
They are freely-transferable if in the name of a good nominee, such as the Depository Trust Corporation
443
If a UK based REIT pays at least 90% of the rental income to shareholders, then the REIT will not need to pay:
Corporation tax
444
The £ vs. $ rate is currently $1.5585 - 1.5595. The sterling equivalent of converting $100,000 is:
DIFF WHEN IT SAYS CONVERTING We would buy sterling at $1.5595. Therefore: $100,000/1.5595 = £64,123.
445
Which of the following is NOT true of equity warrants?
They may pay a fixed or variable income Warrants are only issued by companies, and generate cash for the company on exercise. They are all listed on the LSE and can be traded there, though in practice many warrants are traded OTC. Warrants are not shares, and so do not pay any dividend to the holder.
446
Which of the following are true of eurobonds?
Interest is usually paid before the deduction of withholding tax They are usually in bearer form
447
What is the correct form for collateral if ADRs are to be traded in pre-release format?
Cash
448
Which of the following is true of call options but not true of warrants?
On exercise they do not dilute the shareholding
449
Which of the following is correct in relation to the transferability of American depositary receipts (ADRs)?
They are freely-transferable if in a 'good marking name'
450
Warrants vs Options
Exercise of a warrant is against the company. Exercise of an option is against the writer of the option.
451
Which of the following is true of the currency markets?
London is the largest centre for trading
452
What is collective investment
An arrangements that enables a number of investors to pool their assets and have these professionally managed by an independent manager
453
Unregulated collective investment scheme in UK
UCIS (hedge fund)
454
Regulated collective investment scheme in UK
Recognized: UCITS. can market to EEA Authorized: Domestic funds- market to domestic only
455
What restrictions do regular collective investment schemes have
- concentration (must be diversified) - controlling interest (max exposure to a company) - Borrowing (cannot be highly geared)
456
Look at summary table
457
Investment trust Legal structure open/closed holdings supervision managed investment rules borrowing powers pricing value
Company Closed ended Shares Independent auditors Fund manager Flexibility Can borrow Bid-offer Market sentiment
458
Unit trust Legal structure open/closed holdings supervision managed investment rules borrowing powers pricing value
Trust open ended units Trustee Fund manager Defined rules limited ability to borrow bid-offer NAV
459
OEIC/ICVC Legal structure open/closed holdings supervision managed investment rules borrowing powers pricing value
Company Open Shares Depositary AUTHORISED CORPORATE DIRECTOR Defined rules Limited ability to borrow SINGLE NAV
460
Is SICAU open or closed
open ended
461
What does open ended mean
Supply can be changed infinitely to match demand Units/shares not transferrable No secondary market
462
Major disadvantage of CIS
Lack of price transparency - true value of unit assessed once a day
463
What can closed ended funds do
- Shares trade on secondary market (ordinary and preference) - Can use gearing _ can invest in unquoted private companies
464
What is a venture capital trust
Closed ended vehicles, which invest in relatively new start up companies. traded on LSE
465
What is a split investment trust
Companies set up for limited period eg 5 years Issues 3 types of shares - 0 div pref - Income shares - Capital shares (no income), whatever left after above paid
466
What is an ETF (exchanged traded fund)
Open ended, trades at NAV BUT ALSO TRADEABLE ON SECONDARY market
467
Difference between structured deposit and structured investment
Structured deposit- returns on deposit linked to performance of another asset (affects interest). GUARANTEED BY FSCS Structured investment has NO FSCS GUARANTEE
468
LOOK AT PAYOUT STRUCTURES
469
Disadvantage of open ended property fund
Management costs can erode returns Redemption moratoria- redemptions infrequent
470
Who is responsible for repairs in residential vs commercial property
residential - landlord responsible commercial - tenant responsible
471
From which of the following organisations would an investor normally buy shares in an exchange-traded fund?
Broker Shares in an ETF would normally be purchased from a broker as they trade on exchange.
472
Which of the following products can be traded real-time, giving an investor the ability to track an index at low cost?
ETF
473
With regard to an open-ended investment company, where would you acquire shares?
Authorised corporate director
474
Who can an investor buy units in a unit trust from?
Manager
475
How are shares in an open-ended investment company MOST LIKELY to be priced?
Single-pricing based on the value of the underlying shares
476
Investment trusts are normally:
Limited companies
CISI (CMP) Securities
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