Banking Operations Homework

Carlos Pontón.

Yield.- Is the income or the return on a investment.

Interest Rate.- Is the amount charge for a loan, or the price of borrow money.

Discount rate.- is an interest rate a central bank charges to financial institutions that
borrow reserves from it. In Our case the federal reserve. It also means a cost of capital
rate, adjusted to a risk factor based on the risk inherent by the kind of investment.

Compound interest.- is the concept of adding accumulated interest back to the

principal, so that interest is earned on interest from that moment on.

Yield to call.- is the Rate on Return on the bond's cash flows, assuming it is called at
the first opportunity, instead of being held till maturity.

Yield to maturity.- is the Rate of Return on the bond's cash flows until its maturity
date therefore it includes all the income and all the capital payments due on the bond.

Yield Curve.- is a curve on a graph in which the yield of fixed-interest securities is

shown against the time left to maturity, it usually slopes upwards, but could change
when there are expectations of changes in the interest rate.

The nominal yield or coupon yield is the yearly total of coupons (or interest) paid
divided by the Principal (Face) Value of the bond.

The current yield is those same payments divided by the bond's spot market price.

The yield of a bond is inversely related to its price today: if the price of a bond falls, its
yield goes up. Conversely, if interest rates decline (the market yield declines), then the
price of the bond should rise (all else being equal).

Real interest rate.- the actual interest rate less the current rate of inflation. The real
interest rate therefore expresses the cost of borrowed funds after the expected erosion of
the value of those funds due to the rise in the general price level. The formula is: real
interest rate = nominal interest rate - expected inflation

Nominal interest rate.- rate of interest before adjustment for inflation, or without
adjustment for the full effect of compounding.
Types of bonds.
• Bond (finance), in finance, a debt security, issued by Issuer
o Government bond, a bond issued by a national government
 Government bond register, a register of bonds issued by a
national government, such as the Canadian Government Bond
Register
 War bonds, a type of government bond used to raise funding for a
war effort
o Municipal bond, a bond issued by a city or local government
o Bond market, a financial market for bonds
• Insurance bond (or investment bond), a life assurance-based single premium
investment
• Surety bond, a three party contract, where the surety promises to pay the obligee
for non-performance or dishonesty by the principal
o Performance bond, a surety bond for completion of work under a
contract
o Bail bond, a surety bond for return of a person to a court
• Tenancy bond (or damage deposit), a deposit taken by a landlord in relation to
rental of a property
• Catastrophe bond (or cat bond), a form of reinsurance
• Bonded labor (or debt bondage), a system of servitude where someone must
work to pay off a debt

Bonds enable the issuer to finance long-term investments with external funds. Note that
certificates of deposit (CDs) or commercial paper are considered to be money market
instruments and not bonds.

• Fixed rate bonds have a coupon that remains constant throughout the life of the
bond.

• Floating rate notes (FRNs) have a coupon that is linked to an Index. Common
Indices include: money market indices, such as LIBOR or Euribor, or CPI (the
Consumer Price Index). Coupon examples: three month USD LIBOR + 0.20
• FRN coupons reset periodically, typically every one or three months. In theory,
any Index could be used as the basis for the coupon of an FRN, so long as the
issuer and the buyer can agree to terms.

• High yield bonds are bonds that are rated below investment grade by the credit
rating agencies. As these bonds are more risky than investment grade bonds,
investors expect to earn a higher yield. These bonds are also called junk bonds,
and the risk is due high probability of default.

• Zero coupon bonds do not pay any interest. They are issued at a substantial
discount from par value. The bond holder receives the full principal amount on
the redemption date.
• Inflation linked bonds, in which the principal amount is indexed to inflation. The
interest rate is lower than for fixed rate bonds with a comparable maturity.
However, as the principal amount grows, the payments increase with inflation.
Other indexed bonds, for example equity-linked notes and bonds indexed on a
business indicator (income, added value) or on a country's GDP.

• Asset-backed securities are bonds whose interest and principal payments are
backed by underlying cash flows from other assets. Examples of asset-backed
securities are mortgage-backed securities (MBS's), collateralized mortgage
obligations (CMOs) and collateralized debt obligations (CDOs).

• Subordinated bonds are those that have a lower priority than other bonds of the
issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of
creditors. First the liquidator is paid, then government taxes, etc. The first bond
holders in line to be paid are those holding what is called senior bonds. After
they have been paid, the subordinated bond holders are paid. As a result, the risk
is higher. Therefore, subordinated bonds usually have a lower credit rating than
senior bonds. The main examples of subordinated bonds can be found in bonds
issued by banks, and asset-backed securities. The latter are often issued in
tranches. The senior tranches get paid back first, the subordinated tranches later.

• Perpetual bonds are also often called perpetuities. They have no maturity date.
The most famous of these are the UK Consols. Some of these were issued back
in 1888 and still trade today. Some ultra long-term bonds (sometimes a bond can
last centuries: West Shore Railroad issued a bond which matures in 2361 (i.e.
24th century)) are sometimes viewed as perpetuities from a financial point of
view, with the current value of principal near zero.

• Bearer bond is an official certificate issued without a named holder. In other

words, the person who has the paper certificate can claim the value of the bond.
Often they are registered by a number to prevent counterfeiting, but may be
traded like cash. Bearer bonds are very risky because they can be lost or stolen.

• Registered bond is a bond whose ownership (and any subsequent purchaser) is

recorded by the issuer, or by a transfer agent. It is the alternative to a Bearer
bond. Interest payments, and the principal upon maturity, are sent to the
registered owner.

• Book-entry bond is a bond that does not have a paper certificate. As physically
processing paper bonds and interest coupons became more expensive, issuers
(and banks that used to collect coupon interest for depositors) have tried to
discourage their use. Some book-entry bond issues do not offer the option of a
paper certificate, even to investors who prefer them.

• Lottery bond is a bond issued by a state, usually a European state. Interest is

paid like a traditional fixed rate bond, but the issuer will redeem randomly
selected individual bonds within the issue according to a schedule. Some of
these redemptions will be for a higher value than the face value of the bond.