Investments - Lect. 9-11

Question 1

Behavioral Finance - 2 main irrationalities in people’s behavior are:

Answer 1

1) Investors do not process information correctly and thus infer incorrect probability distributions about future rates of return,
(2) Given a correct probability distribution of returns, they make inconsistent or systematically suboptimal decisions

Question 2

P/E effect can be explained by:

Answer 2

Earnings expectations being too optimistic

Question 3

Funds that typically trade for a discount

Answer 3

Closed-Ended Funds

Question 4

A borrowing arrangement where the borrower sells (issues) the _____ to the lender for some amount of cash

Answer 4

Bonds

Question 5

Bond Annual Payment =

Answer 5

Coupon Rate x Bond’s Par Value

Question 6

What must you account for when buying/selling on the secondary market?

Answer 6

Accrued Interest

Question 7

Invoice Price of Bond =

Answer 7

Stated Price + Accrued Interest

Question 8

6 relationships about bond prices and yields

Answer 8

1) Prices and yields are inversely related, (2) Increasing the YTM results in a smaller price change than a decrease in yield of similar magnitude, (3) Bonds with longer maturities tend to be more sensitive, (4) Sensitivity to yields increases at a decreasing rate as maturity increases, (5) Sensitivity is inversely related to the bond’s coupon rate, (6) Sensitivity is inversely related to the YTM at which the bond is currently selling

Question 9

The weighted average of the (time periods we receive our payments for the bond) where the weights are the percentage of the present value of the bond received in that particular period is called what?

Answer 9

Duration

Question 10

5 rules for durations:

Answer 10

(1) Duration of a zero-coupon bond equals its time to maturity, (2) For a given YTM and maturity, a bond’s duration is higher when the coupon rate is lower, (3) For a given coupon rate, a higher maturity generally results in a higher duration, (4) Cetaris paribus, a lower yield to maturity results in a higher duration, (5) Duration of a level perpetuity is (1+y)/y (y is yield to maturity)

Question 11

Cash Flow Matching - How to do this?

Answer 11

Get zero-coupon bonds equal to the projected cash outlays

Question 12

What method of estimation is most accurate with small changes in yield?

Answer 12

Duration

Question 13

What can we use to calculate an estimated change in price?

Answer 13

Modified Duration = -D*(change in y)

Question 14

Using modified duration to estimate price changes assumes what?

Answer 14

Assumes this relationship is linear, when in really is not

Question 15

What is the actual graphical relationship between modified duration and estimate price changes called?

Answer 15

Convexity of the Bond

Question 16

Interest rate fluctuations can affect the ______ of securities.

Answer 16

Prices

Question 17

A zero coupon bonds Duration is equal to:

Answer 17

-yr of the Bond

Question 18

What concept encapsulates the interest rate risk for a bond?

Answer 18

Duration

Question 19

“Stripping” a 10-year coupon bond yields:

Answer 19

20 coupon payments (from 6-month to 10 years) + 1 representing the principal

Question 20

What 2 things differ if we can’t reinvest coupons at the Yield to Maturity?

Answer 20

Yield to Maturity and Realized Compound Return might differ