FIN30021 Fixed Income and Debt Markets Tutorial Exercises Topic 1
1. Give three reasons why the maturity of a bond is important.
- The maturity gives the holder of the bond expect amount of the coupon payments and the
number of years before the principal will be paid in full.
- the maturity is important because the yield on a bond depends on it. The shape of the yield
curve determines how the maturity affects the yield.
- . the price of a bond will fluctuate over its life as yields in the market change. The volatility
of a bond's price is dependent on its maturity. More specifically, with all other factors
constant, the longer the maturity of a bond, the greater the price volatility resulting from a
change in market yields.
I. The maturity is important because it indicates the period of time over which the holder
can expect coupon payments and how long they must wait for the principal to be repaid.
II. The yield of the bond depends on the maturity
III. The price of the bond will change as the market yields change.
2. Suppose that coupon reset formula for a floating-rate bond is: 1-month
LIBOR + 130 basis points.
a. What is the reference rate? 1 month LIBOR
b. What is the quoted margin? The quoted margin is the 130 basis
points (or 1.30%)
c. Suppose that on coupon reset date that 1-month LIBOR is 2.4%.
What will the coupon rate be for the period? The coupon reset
formula is: 1-month LIBOR + 130 basis points. Therefore, if 1month LIBOR on the coupon rate is reset for that period at 2.4% +
1.30% = 3.70%
Suppose that the coupon reset formula for a floating rate bond is:
1-month LIBOR + 220 basis points
What is the reference rate?
What is the quoted margin?
Suppose on a coupon reset date that 1-month LIBOR is 2.8%. What will the coupon rate
be for the period?
.The reference rate is the 1-month LIBOR.
The quoted margin is 220 basis points.
IF the LIBOR rate is 2.8%, then the coupon rate will be (2.8+ 2.2) = 5%
3. What is a deferred coupon bond?
Deferred-coupon bonds are coupon bonds that let the issuer avoid using cash to make
interest payments for a specified number of years. There are three types of deferred-
coupon structures: (1) deferred-interest bonds, (2) step-up bonds, and (3) payment-inkind bonds.
4. Answer the below questions.
a. What is meant by an amortizing security?
- The principal repayment of a bond issue can be for either the total principal to be
repaid at maturity or for the principal to be repaid over the life of the bond. In the
latter case, there is a schedule of principal repayments. This schedule is called an
amortization schedule. Loans that have this amortizing feature are automobile
loans and home mortgage loans. There are securities that are created from loans
that have an amortization schedule. These securities will then have a schedule of
periodic principal repayments. Such securities are referred to as amortizing
securities.
Amortizing securities are securities that are created from loans that have an
amortization schedule. The principal is paid back over time.
It is not useful because the stated maturity only identifies when the final principal
payment will be made.
b. Why is the maturity of an amortizing security not a useful measure?
- For amortizing securities, investors do not talk in terms of a bond's maturity. This
is because the stated maturity of such bonds or securities only identifies when the
final principal payment will be made. For an amortized security, the repayment of
the principal is made through multiple payments over its maturity and not just at
the end of its term to maturity. Thus, the maturity is not a useful measure in terms
of identifying when the principal is repaid.
5. What does the call provision for a bond entitle the issuer to do?
A call provision grants the issuer the right to retire the debt , fully or
partially , before the scheduled maturity date .
The call provision entitles the issuer to retire the bond before maturity.
6. Answer the below questions.
a. What is the advantage of a call feature for an issuer?
The advantage of a call option for the issuer is that they can retire the bonds if
interest rates drop below coupon rates.
b. What are the disadvantages of a call feature for the bondholder?
The disadvantages of a call provision for the holder are:
There is reinvestment risk for the holder, as the investor will reinvest their capital
into a market with lower interest rates.
The holder cannot determine the cash flow pattern.
The price of a callable bond may not rise above the price at which the issuer will call
the bond.
7. What does the put provision for a bond entitle the bondholder to do?
A put provision entitles the holder to retire the bond earlier than the maturity date date.
8. What are a convertible bond and an exchangeable bond?
Convertible bonds are when the investor can convert the bond into shares of common
stock in the firm that they purchased the bond from. Exchangeable bonds, however, allow
the investor to convert the bond into shares of common stock in another firm.
9. Describe the coupon interest characteristics of this bond.
The characteristics are based on the floating-rate bonds, which are issues
where the coupon rate resets periodically (the coupon reset date) based on
a formula. The formula, referred to as the coupon reset formula, has the
following general form: reference rate + quoted margin
The quoted margin is the additional amount that the issuer agrees to pay
above the reference rate. For example, suppose that the reference rate is
3.5% and the quoted margin is 150 basis points. Then the coupon reset
formula is 1-month LIBOR + 150 basis points = 3.5% + 1.5% = 5.0%
If the 1-month LIBOR on the coupon reset date is 3.5%, the coupon rate is
reset for that period at 5.0% .
What is the CF of a 10 yr bond that pays coupon interest semiannually, has
a coupon rate of 7% and a par value of $100,000?
The Cash flow is 7,000 a year (3,500 twice a year)
What is the CF of a 7 yr bond with no coupon and a par value of $10,000?
No cash flow until the principal is paid back
What is a bond with an embedded option?
A bond with an embedded option gives the bondholder or issuer the option to take action
on the bond against one another. For example, the bond may have a call option that
grants the issuer the right to retire the debt before maturity. Similarly, there can be a put
option for a bondholder, giving them the option to sell the issue before the maturity date.
Other options include convertible or exchangeable options for the holder to convert the
bond into shares of common stock.
How do market participants gauge the default risk of a bond issue?市场参
与者如何衡量债券发行的违约风险？
They can gauge the default risk of a bond issue by looking at the credit
rating assigned to a bond issue. 他们可以通过查看分配给债券发行的信用
评级来衡量债券发行的违约风险。
Explain whether you agree or disagree with the following statement:
"Because my bond is guaranteed by an insurance company, I have
eliminated credit risk." 解释您是否同意以下陈述：“因为我的债券是由保
险公司担保的，所以我已经消除了信用风险。
This is not true, Insurance companies, like in 2007, can face downgrading
risk, indicating that their credit rating has dropped. 事实并非如此，保险
公司和2007年一样，可能面临降级风险，说明他们的信用等级已经下降
。
Does an investor who purchases a zero-coupon bond face reinvestment risk?
Actually a little risk because of lump sum reinvested
购买零息债券的投资者是否面临再投资风险？
一次性再投资其实有点风险