Fixed Income Securities Flashcards

What is the primary purpose of the 'yield curve'?

Answer: To illustrate the relationship between yield and time to maturity for bonds of similar credit quality

The yield curve plots yields against maturities for bonds of similar credit quality, allowing investors to assess the term structure of interest rates.

An 'inverted yield curve' typically signals:

Answer: Expectations of falling interest rates or an impending economic slowdown

An inverted yield curve, where short-term yields exceed long-term yields, has historically been associated with expectations of economic slowdown or recession.

Which of the following best describes a 'convertible bond'?

Answer: A bond that gives the holder the right to convert into a specified number of equity shares

A convertible bond gives the bondholder the option to convert the bond into a predetermined number of the issuer's ordinary shares, offering equity upside alongside bond income.

The 'clean price' of a bond differs from the 'dirty price' in that:

Answer: The clean price excludes accrued interest, while the dirty price includes it

The dirty (or full) price includes accrued interest since the last coupon; the clean price strips this out to make comparison between bonds easier.

Which of the following is a characteristic of 'high yield' (sub-investment grade) bonds compared to investment-grade bonds?

Answer: Higher yields and greater credit risk, but potentially higher returns

High yield bonds carry a higher probability of default than investment-grade bonds and therefore offer higher yields to compensate investors for the additional credit risk.

In the context of bond markets, what is 'duration matching' (immunisation) used for?

Answer: Aligning the duration of assets and liabilities to protect against interest rate movements

Duration matching (immunisation) involves setting the duration of a bond portfolio equal to the duration of liabilities, so that interest rate changes affect both sides equally.

What does 'basis risk' refer to in fixed income markets?

Answer: The risk that the yield spread between two related instruments changes unexpectedly

Basis risk arises when two related instruments (e.g., a bond and a futures contract used to hedge it) do not move perfectly in tandem, leaving residual exposure.