Question

In: Finance

-Is negative Sharpe ratio good or bad? - What is the difference between the coupon rate...

-Is negative Sharpe ratio good or bad?
- What is the difference between the coupon rate and the current interest rate for a bond?
-what is the difference between a sinking fund and a call feature ?
-what is the lowest investment rated bond rating?
-What is a high yield bond and what would be its' bond rating?

Solutions

Expert Solution

Is negative Sharpe ratio good or bad?

The Sharpe ratio is a way to determine how much return is achieved per each unit of risk. It is useful and can be computed by, all forms of capital market participants to evaluate their performance

Naturally, when evaluating the performance of traders and investors it is not simply a matter of determining their overall return, but their return relative to their risk.

Sharpe Ratio = (Return of Portfolio – Risk-Free Return) / Std Dev of Portfolio

A value between 0 and 1 signifies that the returns derived are better than the risk-free rate, but their excess risks exceed their excess returns. A value above 1 denotes that the returns are not only better than the risk-free rate, but excess returns are above their excess risks

A negative Sharpe ratio means that the performance of a manager or portfolio is below the risk-free rate.

Difference between the coupon rate and current interest rate

A coupon rate refers to the rate which is calculated on the face value of the bond. It is a fixed % of Face Value paid to a bond investor by a bond issuer, it is usually decided by the issuer of the bonds coupon rate.

whereas,

The current interest rate is the amount charged by the lender from the borrower, which is calculated annually on the amount that has been lent. The interest rates are being affected by the change in the market scenario. The interest rate does not depend on the issue price, face value or coupon rate; it is already being decided by the issuing party. The market interest rates have effects on the bond prices and yield

The current interest rate changes the current market price of the bond, but the face value of the bond and Coupon rate is fixed.

Difference between a sinking fund and a call feature

On the other hand, sinking funds are provisions that stipulate the amount of principal that will be retired annually over the life of a bond. The company calls back some of the bonds randomly which will reduce the pressure of paying back all the principal value at maturity

whereas,

In the Call feature, the company decides the callable dates and the company have the right to call back all the bonds.

Example :

Let's say a company-issued 10 year bond with a coupon rate of 10% and a callable after 2 years.

after 2 years if the Market interest rate for same risk and maturity is 5% the company may issue a new bond at a coupon rate of 5% and call back the previously issued bonds because it makes no sense to pay a coupon rate of 10% whereas you can pay a coupon of 5%.

What is the lowest investment rated bond rating?

The company must be rated at

'BBB' or higher by Standard and Poor's or

Baa3 or higher by Moody's.

Anything below this 'BBB' or Baa3 rating is considered non-investment grade.

What is a high yield bond and what would be its' bond rating

High-yield bonds are bonds that pay higher interest rates because they have lower credit ratings than investment-grade bonds. High-yield bonds are more likely to default, so they must pay a higher yield than investment-grade bonds to compensate investors. Issuers of high-yield debt tend to be startup companies or capital-intensive firms with high debt ratios. High-yield bonds are also called junk bonds.


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