Practising through Application

Someone close to me told me that learning through application of CFA knowledge from the real world can help in better understanding of the topics. Initially I didn't realize its importance but after watching myself during the exam connecting topics with news headlines and other bloomberg articles, I can understand its significance. The first three readings of fixed income require understanding and a bit more practice but the last three readings require in depth understanding of MBS, ABS and their valuation. Retaining tranching, CDOs, CMOs, their structures etc. is a tough job. Reading about these instruments more over the internet especially articles and news related to these helps in connecting the topics with the real world happenings. It improves the ability to retain and recall. It worked for me remarkable trying that can also help you...

PS: I have also mentioned several news items related to Fixed Income and Derivatives over this blog. You can check them through the labels.

Knowledge Application - Treasury Inflation Bond Demand Eases With Yields at Record Lows

Treasury Inflation Protected Securities (TIPS) have been elaborated in the CFA Level I Curriculum. The following Bloomberg article highlights issues related to TIPS and what is going in the real world involving these securities.

Read the article: http://www.businessweek.com/news/2012-02-17/treasury-inflation-bond-demand-eases-with-yields-at-record-lows.html

News Pick - Sovereign, Corporate Bond Risk Rises, Credit-Default Swaps Show

How Credit Default Swaps operate and the nature of such instruments a long with their relation with the Corporate Bond Risk have been explained in the CFA Level II Curriculum, Fixed Income. If you've covered that area and you are aware of the relationship between Corporate Bond Risk and Credit Default Swap then this  story of Bloomberg will make sense to you.

Read the article: "http://www.bloomberg.com/news/2012-02-27/sovereign-corporate-bond-risk-rises-credit-default-swaps-show.html"

News Pick (Bloomberg) - JPMorgan Places $72B Bet on Homeowners

Another interesting article related to Mortgage Loans comprising plenty of terms related to Fixed Income. Candidates of Level II particularly who have covered Mortgage Backed Securities will find reading this article as a bridge of what they have been studying a long with the real world.

Read the article: http://www.bloomberg.com/news/2012-02-23/jpmorgan-wagers-72-billion-on-global-home-loans-in-yield-hunt-mortgages.html

Inflation & Change in Interest Rates in U.S.

Below are the trends lines of Inflation, as measured by percentage change in Producer Price Index, with quarterly frequency and base year 1982, and 3 months U.S. Treasury Bill Interest Rates. I ran a regression on both of these values and got the adjusted R square to be 6.7% which is quite less. The trend graphs also show independent results. Why there is no relation between these two variables... I haven't figured it out but the trends are interesting. 

U.S. Treasury planning to issue floating-rate securities for the first time?

Floating rate securities have been discussed in CFA Level I curriculum. The coupon on such securities reset periodically through a reset formula with some reference rate. U.S. Treasury has decided to issue floating rate securities for the first time. The reasons why U.S. Treasury has decided to do so can be read on the article published in Daily Finance.

Read the article: http://www.dailyfinance.com/2012/02/10/the-us-treasury-wants-you-to-buy-this/

U.S. Strips Formation Falls for Sixth Month Amid Twist Program

Fixed income is an important area of CFA Curriculum. Zero coupon bonds and treasury strips are covered in detailed in both Level I and Level II. What's going on with the bond market in U.S. especially with strips can be visualized through this article.

Read the article: http://www.businessweek.com/news/2012-02-07/u-s-strips-formation-falls-for-sixth-month-amid-twist-program.html

U.S Treasury Securities, Coupons, Maturity Dates & Yields

Issues	Coupon	Maturity	Yield
3-Month	0	05/10/2012	0.08
6-Month	0	08/09/2012	0.1
12-Month	0	02/07/2013	0.14
2-Year	0.25	01/31/2014	0.25
3-Year	0.25	02/15/2015	0.35
5-Year	0.875	01/31/2017	0.82
7-Year	1.25	01/31/2019	1.4
10-Year	2	11/15/2021	1.99
30-Year	3.125	11/15/2041	3.16

Which theory is the curve following? I think investors demand liquidity premium for holding securities which are for longer maturities.

Housing Price Conundrum (Part 3)

Housing Price Conundrum (Part 2)

News Pick - NCUA Issues Interest-Rate Risk Rule: Onsite Coverage

Interest Rate Risk is an important type of risk which has been discussed extensively in CFA Level I curriculum. Though the calculations of interest rate risk related to non-parallel shift in the yield curve through key rate duration is discussed in Level II, but a brief but comprehensive overview is present in the Level I curriculum. Below is the link to an article which discusses Interest rate risk and its importance in the financial world.


Read the article: http://www.cutimes.com/2012/01/26/ncua-issues-interest-rate-risk-rule-onsite-coverag?ref=hp

News Pick - Italy sells top amount at bond sale, yields fall

Below is the link to the article written in Reuters. Fixed income is a detailed Study Session in Level I and Level II and it exposes to the major terminologies used in the bond market. Those who have gone through this study session in Level I or in Level II will enjoy reading this.


Read the article: http://www.reuters.com/article/2012/01/26/us-italy-bonds-auction-idUSTRE80P0K020120126

Glossary - Fixed Income

1. Sinking Fund Provision: It requires that the issuer to retire the fixed portion of bond's principal each year.

2. Accelerated Sinking Fund Provision: It allows the issuer to retire more than the amount that is stipulated by the Sinking Fund Provisions.

3. Redeemed: Bonds are redeemed when they are called through a call option or sinking fund provisions.

4. Refunded: Bonds are refunded whey they are called using the funds obtained through issuing lower coupon bonds.

5. Convertible Bond: A convertible bond is an issue that provides the investor the option or right to convert the bond into a specified number of shares of common stock.

6. Exchangeable Bond: An exchangeable bond provides the investor the option to exchange the bonds for a fixed number of shares of common stock of a company other than the issuer of the bond. 

Glossary - Fixed Income

Regular Redemption Price: Regular or general call redemption pricing is normally set at a premium price above par until the first par call date.

Special Redemption Prices: It is normally set for bonds redeemed through sinking fund or other special redemption conditions. The special redemption pricing is usually set at par value.

Par Call Problem: Problem which arises when the issuer maneuvers a call so that the issue can be redeemed at special redemption price instead of regular or general call redemption price.

Prepayment: Any principal payment paid prior to a scheduled principal payment date is called prepayment.

Prepayment option: An option which allows the borrower to repay the principal before due date.

Glossary - Fixed Income

1. Call Provision: It grants the issuer an option to retire all or part of the issue prior to the stated maturity date.

2. First call date: The first date of call or redemption.

3. Redemption Price: The price at which the issuer must pay to retire the bond early is referred to as the call price or redemption price.

4. Make-whole redemption price: It is equal to the premium plus the principle at which the issue is called.

5. Currently callable: Bonds with no protection against called early.

6. Non-callable bonds: Bonds having some restrictions against early redemption.

7. Non-refundable bonds: Bonds which prohibit the issuer from redeeming by issuing fresh bonds at lower coupon rate.

Glossary - Fixed Income

Bullet Maturity: Bonds with entire amount paid as lump sum payment at maturity.

Non amortizing securities: Securities that only pay interest during the tenure and the entire principal is paid at maturity

Amortizing Securities: Securities that repay both interest and the principal amount over the tenure of the bond.

Sinking fund provision: A kind of amortizing feature in which issuer can pay all of an issue by the maturity date or may only repay a part of the total by the maturity date.

Glossary - Fixed Income

Zero Coupon Bonds: Bonds not contracted to make periodic coupon payments. Interest is realized by the bond holder by buying the bond at substantially below its par value.

Interest of Zero coupon bond: The difference between the par value, realized at maturity and the purchase price.

Step-up Notes: Securities with coupon rate that increases over time.

Deferred coupon bonds: Bonds with coupon payment deferred for a period of time. Payments made after deferred period are higher than interest payments to compensate for lack of interest payment during deferred period.

Floating-rate securities (floater): Also called variable rate securities, do not have fixed coupon rate. Coupon payments reset periodically according to some reference rate.

Cap: The maximum coupon rate for a floater.

Floor: The minimum coupon rate for a floater.

Inverse Floater: Floating securities whose coupon rate moves in opposite direction to the reference rate. Increase in reference rates case decrease in coupon for floaters and vice versa.

Glossary - Fixed Income

Coupon Rate: The interest rate promised in a contract; this is the rate used to calculate the periodic interest payments.Also known as the nominal rate.

Coupon: The annual amount of interest payment made to the bondholder during the term of the bond.

Maturity: Number of years remaining prior to final principle payment. Years when the debt is outstanding.

Short term bonds: Maturity 1 to 5 years.

Intermediate-term bonds: Maturity 5 to 12 years

Long term bonds: Maturity over 12 years

Par value: Amount of bond that the issuer promises to repay to the bond holder at or by maturity date. Also termed as face value, maturity value, principle value and redemption value.

Glossary - Fixed Income

Investors/Bond holders/Lenders: Those who have purchased the bonds or invested in the company

Borrowers/Bond issuers: Those who have issued the bonds.

Bond Indenture: The contract that specifies all rights of the investors & obligations of the issuers.

Covenants: Provisions of the bond indenture.

Affirmative covenants: Actions that borrowers promise to perform e.g. maintenance of certain financial ratios, timely payment of principal and interest etc.

Negative covenants: Prohibitions on the borrowers e.g. restrictions on additional borrowings, negative pledge of collateral etc.