Final Review Flashcards
Municipal Bonds
General Obligation Bonds- backed by the full faith,, credit and taxing authority of the municipality that issued the bond. Revenue bonds- Backed by the revenue of a specific project. Private Activity bond- used to fund construction of stadiums. Insured municipal bonds- American Municipal Bond Assurance Corp. Municipal Bond Insurance Association.
Tax Equivalent & Tax Exempt Y8ield
(Tax equivalent yield)= (tax-exempt yield/ 1- marginal tax rate)
Liquidity Preference Theory
The yield curve results in lower yields for shorter maturities because investors prefer liquidity and are willing to pay for liquidity in the form of lower yields.
Market Segmentation Theory
The yield curve depends on supply and demand at a given maturity. If the demand for a category of bonds exceed the supply, then the seller can get a higher price, which means a lower yield. In an inverted curve, the yield for ST bonds is higher than LT bonds, which means the demand for ST bonds must be lower than the supply
Expectations Theory
The yield curve reflects investors inflation expectations. Typically, since investors are uncertain or believe inflation will be higher in the future, long term yields are higher than short term yields.
Bond Duration indicates:
A bond’s price sensitivity to changes in interest rates. The higher the duration, the more price sensitivity or volatile the bond is to interest changes. Its the moment in time the investor is immunized from interest rate reinvestment risk. Its the weighted average time until an investor receives all the coupon payments and principal. A bond portfolio should maintain a duration equal to the investor’s time horizon to be effectively immunized. The duration of a portfolio is a weighted average.
Calculating the duration of a bond
A zero coupon bond will always have a duration equal to its maturity. As the coupon rate increases, the duration decreases. For example Bond A 30 year zero coupon bond duration 30. Bond B 30 year 5 percent bond duration 27. Bond C 30 year 10 coupon bond duration= 10.
Estimating Bond Price
Duration can also be used to estimate the price change of a bond.
