Chapter 21 Flashcards
Measures of Recent Economic Activity
GDP, employment, housing, retail sales, industrial surveys, trade balance
Measures of inflation
CPI, producer price index, GDP price deflator
Measures of future economic activity
index of leading indicators, consumer confidence
Monetary Policy
he control of the quantity of money available in an economy and the channels by which new money is supplied.
Interest Rate Policy
Sets the official short term interest rate (overnight rate) which is the interest rate at which financial institutions can borrow and lend one-day funds among themselves
Open Market Operations
Involve the purchase or sale of T-bills or government bonds by the BOC which influences the overall money supply (BOC sells securities, money supply decreases; BOC buys securities, money supply increases)
Fiscal Policy
Fiscal policy guides the spending a government undertakes to provide goods and services and determines the way in which the government finances these expenditures
How is government spending financed?
Taxation and borrowing (issuing t-bill/bonds)
Quality Spread Theory
This theory is based on the view that credit spreads are affected by the economic cycle. During an economic recovery, the perception of the quality and safety of non-Government of Canada issues improves. As more money moves into non-Government of Canada issues, the price relative to Canada bonds rises and spreads begin to tighten
Interest Rate Volatility Theory
According to this theory, in times of high interest rate volatility, yield spreads on callable bonds widen, and yield spreads on putable bonds narrow
Which bonds are affected most by change in interest rates?
long term + lower coupon
Duration
a way of measuring how much bond prices are likely to change if and when interest rates move
Macaulay Duration
tells the weighted average time that a bond needs to be held so that the total present value of the cash flows received is equal to the current market price paid for the bond.
Modified Duration
- a measure of the approximate percentage price change for a 100 basis point change in yield
= Macaulay duration/ (1 + (y/k))
where y = yield, and k = # coupon payments per year
Portfolio Modified Duration
The modified duration of a portfolio of bonds is a weighted average of the modified durations of the individual bonds
Convexity
A measure of the curvature in the relationship between bond prices and bond yields that demonstrates how the duration of a bond changes as the interest rate changes
Debt Security Active Strategy
investor forms expectations and shifts assets around to take full advantage of those expectations
Debt Security Passive Strategy
investor’s portfolio is designed to approximate a market index or to reduce the requirement to make decisions based on expectations
Debt Security Dedicated Strategy
designed to meet specific targets and goals
Types of Active Debt Security Stategies
- interest rate strategy
- yield curve strategies
- intermarket spread strategies
- intramarket spread strategies
Interest Rate Strategy
Active investors can attempt to exploit differences between their own interest rate forecast and the forecast embedded in market interest rates
Yield Curve Strategies
are designed by positioning bonds along the maturity spectrum to take advantage of expected changes in the shape of the curve
Bullet Portfolio
portfolio is built with one or more bonds with roughly equal durations
Barbell portfolio
portfolio portfolio is built with one or more bonds with short durations combined with one or more bonds with long durations, the average duration equals that of the bullet portfolio
Intermarket Spread Strategies
designed to capitalize on the difference in yield spreads and expected changes in yield spreads between different sectors of the bond market
Intramarket Spread Strategies
- Involve swapping bonds that are largely similar
- Reason for swap could be based on mispriced securities or relative value differences, or swapping securities for a higher yield
Passive Strategies
- indexation
2. laddering
Stratified sampling approach
Takes a market index and divides it into parts called cells, each cell represents a different portfolio characteristic, such as duration, coupon, maturity, sector, credit rating, or call features
Optimization
Builds on the stratified sampling approach by using mathematical programming to optimize the portfolio based on the stated return objectives and constraints
The Macaulay duration of a zero-coupon bond (including strip bonds) is _______ to the bond’s term to maturity (in years)
equal
The Macaulay duration of a coupon bond is always _____ than the bond’s term to maturity. All else being equal, the _____ the coupon, the longer the Macaulay duration, and the _____ the term to maturity, the longer the Macaulay duration
less
smaller
longer
The real value of Macaulay duration is that it can be used to:
calculate modified durations, which is a much more useful measure of bond price volatility
All else being equal, the longer the term to maturity, the ________ the modified duration
greater
All else being equal, the lower the coupon rate, the _______ the modified duration
greater
All else being equal, the lower the yield, the _______the modified duration
greater
Modified duration is always ______ than the term to maturity
less
