Fixed Income and Money Market Instruments
Key Concepts
- Bond basics: Issuer types (government, municipal, corporate), credit risk, interest rate risk, and yield measures (coupon, current yield, YTM).
- Money market instruments: T-bills, commercial paper, CDs, repos, and their features (short-term, high liquidity, low risk).
- Pricing and yields: Inverse relationship between bond prices and yields; duration as a measure of sensitivity.
- Municipal bonds: Tax-exempt interest, general obligation vs. revenue bonds.
- Yield curve: Normal, inverted, flat; implications for expectations.
Traps
- Assuming bond prices and yields move together (they move inversely).
- Forgetting that municipal bond interest is often exempt from federal tax, but capital gains are not.
- Mixing up T-bills (discount) with T-notes/bonds (coupon).
Worked Example / Rule of Thumb
Rule of thumb: If yields rise by 1%, a bond with duration 5 loses about 5% in price. Example: A bond with duration 5 and yield 3% rises to 4%. Approximate price change = -5 * 1% = -5%.