A term structure theory suggesting that different bond investors prefer one maturity length over another and are only willing to buy bonds outside of their maturity preference if a risk premium for the maturity range is available. The theory also suggests that when all else is equal investors prefer to hold short-term bonds in place of long-term bonds and that the yields on longer term bonds should be higher than shorter term bonds. |||The preferred habitat theory is an expansion on the expectations theory which suggests that long-term yields are an estimate of the future expected short-term yields. The reasoning behind the expectations theory is that bond investors only care about yield and are willing to buy bonds of any maturity, which in theory would mean a flat term structure unless expectations are for rising rates. The preferred habitat theory expands on the expectation theory by saying that bond investor’s care about both maturity and return. It suggests that short-term yields will almost always be lower than long-term yields due to an added premium needed to entice bond investors to purchase not only longer term bonds, but bonds outside of their maturity preference.
A type of bond issued to fund another callable bond, where the issuer actually decides to exercise its right to buy its bonds back before the scheduled maturity date. The proceeds from the issue of the lower yield and/or longer maturing pre-refunding bond will usually be invested in Treasury bills (T-bills) until the scheduled call date of the original bond issue occurs. |||For example, suppose that in June 2006, XYZ Corp decided to call its 9% callable bond (that is originally set to mature in 2009) for $1,100 on its first call date of January 2007. In July, XYZ Corp would have issued a new bond yielding 7% and took all the proceeds from that bond and invested them into T-bills - ensuring that enough money would be availiable to retire the issue come January.Using pre-refunding bonds can be a good method for companies to refinance their older issue bonds when interest rates drop.
Bonds issued by a government agency that purchases U.S. government securities to pledge as collateral for the bond issue. Pre-funded bonds are issued by municipalities that wish to attain a higher credit rating for their debt. Since state-issued bonds are not pledged by the full faith of the U.S government, the underlying collateral minimizes the risk of default. The pre-funded bond and the U.S. securities tend to have the same maturity. |||Pre-funded bonds provide the tax advantages present in regular municipal bonds, but are exposed to less risks. The federal government-based collateral reduces the potential for the issuer's credit to deteriorate.
A non-parallel yield curve shift in which short- and long-term rates shift upward by a greater magnitude than medium term rates. This yield curve shift effectively humps the curve, adding to its curvature. |||A non-parallel shift in the yield curve happens when not all of the maturities on the curve move by the same rate. For example, if short-term and long-term rates move upward by 100 basis points (1%) while medium-term rates remain the same, the convexity of the yield curve will increase. This yield curve shift is called a positive butterfly shift because it causes the curve to hump.
The percentage of the original principal that is left to be distributed in a mortgage-backed security, as represented by a numerical factor that will be attached on periodic market quotes and other presentations of the MBS’s price. Calculated as: |||For example, if the face amount of a pooled MBS is $100,000 and the stated pool factor is 0.4587, the remaining balance in the security, yet to be paid to the investor, would be $45,870. The pool factor is only used to describe mortgage-backed securities, which can be issued by Freddie Mac (FHLMC), Fannie Mae (FNMA) and Ginnie Mae (GNMA). A pooled MBS is one whose component mortgage payments are passed through to the investors, month to month, until the mortgage pool has been completely paid off, instead of being rebundled or collated,
A measure used to describe how a basis point change in yield affects the price of a bond.Also knows as the "value of a basis point" (VBP) or "basis point value" (BPV). |||There is an inverse relationship between bond price and yield. As bond prices decrease, their yields increase and vice versa. The degree of change in bond price for each basis point change in yield is determined by a number of other factors, such as the bond's coupon rate, time to maturity and credit rating.
A factor which can be used to calculate the present value of a series of annuities. The initial deposit, earning interest at the periodic rate (r), perfectly finances a series of (N) consecutive dollar withdrawals. PVIFA is also a variable used when calculating the present value of an ordinary annuity. PVIFA = 1 - (1 + r)^-N r |||The most common values of both N and r can be found in a PVIFA table, which will immediately show the value of PVIFA. This table is a particularly useful tool for comparing different scenarios with variable N and r values.
A convertible bond with an additional put feature that allows it to be redeemed at a premium sometime during its life. |||Similar to a regular put option, the issuer of the premium put convertible bond has an obligation to buy back the bond upon the discretion of the bondholder. Thus, the put option attached to this convertible bond allows it to be redeemed at a premium by the bondholder anytime before maturity.
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