lecture 7 - Click to edit Master subtitle style Prof Irvine...

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Unformatted text preview: Click to edit Master subtitle style Prof Irvine FINA 4310 Prof Irvine FINA 4310 Lecture 7-8 Fixed Income BKM Chapter 10, 11 Prof Irvine FINA 4310 Prof Irvine FINA 4310 22 Bond Basics Coupon bonds and their yields l Coupon bonds Competence assumed l Notes, bonds, debentures l Other features: convertible, putable Not on exams l Yields Coupon rate or yield Current yield Yield to maturity Prof Irvine FINA 4310 Prof Irvine FINA 4310 33 Bond Basics II Zero coupon bonds: ZCB Pay a single payment at maturity No coupons Use ZCB to get spot rates of interest l Face or Par Value ( principal repayment amount) l Price of the Bond Equals par value only if: interest rates=coupon rate Prof Irvine FINA 4310 Prof Irvine FINA 4310 44 Figure 10.2 Investment Grade Bonds Prof Irvine FINA 4310 Prof Irvine FINA 4310 55 Figure 10.8 Definitions of Each Bond Rating Class Prof Irvine FINA 4310 Prof Irvine FINA 4310 66 Factors Used by Rating Companies l Coverage ratios Interest coverage l Leverage ratios Debt/Equity l Liquidity ratios Quick ratio l Profitability ratios ROE Prof Irvine FINA 4310 Protection Against Default l Sinking funds Issuer may repurchase a given fraction of the outstanding bonds each year, or Issuer may either repurchase at the lower of open market price or at a pre-specified price, usually par; bonds are chosen randomly l Serial bonds Staggered maturity dates l Subordination of future debt Senior debt holders must be paid in full before junior debt holders. 10-7 Prof Irvine FINA 4310 Protection Against Default l Dividend restrictions Limit on liquidating dividends l Collateral A specific asset pledged against possible default on a bond. What is a bond called that has no specific collateral? 10-8 Prof Irvine FINA 4310 Prof Irvine FINA 4310 99 Innovations in the Bond Market l Inverse floaters l Asset-backed bonds l Pay-in-kind bonds l Catastrophe bonds l Indexed bonds TIPS (Treasury Inflation Protected Securities) Prof Irvine FINA 4310 Credit Default Swaps A credit default swap (CDS) is an insurance policy on the default risk of a bond or loan. l The seller of the swap collects an annual premium (and sometimes an upfront fee) from the swap buyer. l The buyer of the swap collects nothing unless the bond issuer or loan borrower defaults, in which case the seller of the swap essentially pays the drop in value from par to the swap buyer. 10-10 Prof Irvine FINA 4310 Credit Default Swaps l CDSs can be used to speculate on financial health of firms. Swap buyer need not hold the underlying bond or loan. At their peak there were reportedly $63 trillion worth of CDS; US GDP is about $14 trillion....
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lecture 7 - Click to edit Master subtitle style Prof Irvine...

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