Ch 21 - Debt Securities: Pricing, Volatility and Strategies Flashcards
goals of monetary policy
- foster economic growth
- increase and maintaining employment
- ensure price stability
- maintain stable international financial transactions
Government spending is financed by two means
taxation and borrowing
Quality spread theory
Theory based on the view that credit spreads are affected by the economic cycle.
Good times low spread, bad times high spread
Interest rate volatility theory
As volatility increases, the value of both call and put options increases
Interest rising –> Yield spread rising on callable bonds.
Duration is used to
compare the volatility of bonds that have different coupon rates and different maturities
Three different measures of duration
- Macaulay duration
- Modified duration
- Effective duration
three things to know about Macaulay duration
- Macaulay duration of a zero-coupon bond is equal to the bond’s term to maturity
- Macaulay duration of a coupon bond is always less than the bond’s term to maturity
- real value of Macaulay duration is that it can be used to calculate modified durations
4 Active debt security strategies
- Interest rate strategies
- Yield curve strategies
- Intermarket spread strategies
- Intramarket spread strategies
Intermarket spread strategies
difference in yield spreads between different sectors of the bond market.
Intramarket spread strategies are also known as
substitution swaps
What is an Intramarket spread strategies
involves swapping bonds that are largely similar
Two approaches to building an indexed portfolio
- stratified sampling approach
* optimization approach.
optimization approach
Uses mathematical programming to
optimize the portfolio based on return objectives and constraints.
three types of dedicated strategies
- cash flow matching,
- immunization
- contingent immunization.
