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Question of the Week – Fixed Income

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    • Avatar of AdaptPrepAdaptPrep
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        • Undecided
        13 Jan 2018 at 8:02 pm
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        Keisha is looking to avoid purchasing power risk as much as possible. She should consider investing in which type of security?

        • TIPS
        • Floats
        • Bullet bonds
      • Avatar of hairyfairyhairyfairy
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          • Undecided
          13 Jan 2018 at 8:22 pm
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          AAARGH. @PassedTense‌ I thought TIPS have purchasing power risk!

        • Avatar of AdaptPrepAdaptPrep
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            • Undecided
            20 Jan 2018 at 8:01 pm
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            Treasury Inflation-Protected
            Securities (TIPS)             are designed to protect the purchaser from inflation, by
            paying out a coupon tied to an inflation index.

            Floats protect against interest rate risk, but not purchasing power risk.

            Bullet bonds protect against the risk of the bond being called as they are not callable prior to maturity.

          • Avatar of hairyfairyhairyfairy
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              • Undecided
              14 Jan 2018 at 7:24 am
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              Thanks @jak5189‌!

            • Avatar of simply_complex2simply_complex2
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                • CFA Level 1
                15 Jan 2018 at 1:24 am
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                yep @jak5198! in a nutshell FRNs have less interest rate risk (risk of bond price volatility due to changing market interest rates) because the coupon resets periodically in line with market rates. (so basically you’re right :))

              • Avatar of LeChiffreLeChiffre
                Participant
                  • CFA Level 2
                  18 Jan 2018 at 7:26 am
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                  This question is just a wordy
                  way of asking which investment protects against inflation. I suppose the tricky
                  part is not overthinking it.

                • Avatar of shannondailyshannondaily
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                    • Undecided
                    13 Jan 2018 at 9:44 pm
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                    Woo! I got it right. 

                  • Avatar of simply_complex2simply_complex2
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                      • CFA Level 1
                      14 Jan 2018 at 1:03 am
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                      @jak5189, i believe you are right. FRN (floating rate notes) have less interest rate risk because the coupon rate is reset periodically to be brought in line with current market yields. so from the rate of the investor, it compensates them if market rates increase and from the perspective of the issuer, it protects them in case rates decrease 

                    • Avatar of jak5189jak5189
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                        14 Jan 2018 at 10:46 am
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                        @Simply_complex2, if I am understanding an increase in market interest rates will cause the coupon rate to adjust up to the new market rate to compensate investors for the depreciation in the price of the bond? The compensation is in the form of a higher reinvestment rate? And for the issuer, the decrease in interest rates causes the coupon rate to adjust downward, which allows the issuer to pay out less to the investor. Is that the logic??

                      • Avatar of jak5189jak5189
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                          13 Jan 2018 at 10:56 pm
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                          @HairyFairy, TIPS – Treasury Inflation Protected Securities; Inflation = purchasing power erosion, therefore TIPS would be the proper security for protection. That’s how I remember it. Hopefully that helps 🙂

                          @PassedTense, FRNs protect interest rate risk correct? I am a little unclear on their purpose in risk protection.

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