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Description
Flashcards by Nafisa Zahra, updated more than 1 year ago
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Created by Nafisa Zahra
over 10 years ago
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| Question | Answer |
| What is the term structure of interest rates? | The structure of interest rates used when discounting cash flows of varying maturities |
| What is the forward rate ft | The forward rate ft is the future short rate in year t. |
| What are Treasury Strips | Treasury strips are zero-coupon bonds created by selling each coupon or principal payment from a whole Treasury bond as a separate cash flow. For example a 1 year maturity T-bond paying semiannual coupons can be split into a 6 month maturity zero (by selling the first coupon payment as a stand alone security) and a 12 month zero (corresponding to payment of final coupon and principal) |
| Explain the impact of the offering bond yield when adding a call feature to a bond | The call feature provides a valuable option to the issuer, since it can buy back the bond at a specified call price even if the present value of the scheduled remaining payments is greater than the call price. The investor will demand, and the issuer will be willing to pay, a higher yield on the issue as compensation for this feature. |
| Explain the impact on both bond duration and convexity when adding a call feature to a bond | he call feature reduces both the duration (interest rate sensitivity) and the convexity of the bond. If interest rates fall, the increase in the price of the callable bond will not be as large as it would be if the bond were noncallable. Moreover, the usual curvature that characterizes price changes for a straight bond is reduced by a call feature. The price-yield curve (see Figure 16.6) flattens out as the interest rate falls and the option to call the bond becomes more attractive. In fact, at very low interest rates, the bond exhibits negative convexity |
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