Random Flashcards
Basic Premises in Behavioural Finance
1) Investors are NORMAL
2) Market are INefficient
3) The Behavioral Portfolio Theory governs
Humanistic Paradigm
1) The Majority of Hum.. thoeries view clients as experts on themselves.
2) The alliance between the counselor and client is extremely important for hum.. counselors and is the basis of the treatment or plan of action.
This Paradigm embraces a close, friendly relation- ship between the client and adviser, such that the client will open up and achieve congruence.
Duration
Time-weighted measure of a fixed-income security’s cash flows in terms of payback.
There are three important uses for duration
1. Providing a measure of a bond’s volatility;
2. Estimating the change in the price of a bond based on changes in interest rates; and
3. Immunizing a bond or bond portfolio against interest rate risk.
Duration Summary Notes
Macaulay duration can be thought of as a time-weighted payback period. Bonds with greater durations are more sensitive to interest rate changes.
Characteristics of Macaulay duration:
- The duration of a coupon bond will always be less than its maturity because of the weights given to the intermediate cash flows.
- There is an INverse relationship between coupon and duration. Bonds with higher coupons have lower durations. Note: the duration of a zero-coupon bond always equals its maturity.
- There is a positive relationship between duration and time to maturity. The duration of an 8% coupon bond with twenty years to maturity is greater than the duration of an 8% coupon bond with 15 years to maturity.
- There is an inverse relationship between duration and yield to maturity. As YTM increases, duration decreases.
- Sinking funds and call provisions can change the duration of a bond.
Effective Duration
= (Price if yield declines)-(Price if yield increases)
Divided by
2* (initial price)* (Decimal change in yield)
Bond Swapping
1) Substitution Swap
involve exchanging bonds with identical characteristics (including credit rating, maturity, coupon interest payment, call feature, etc.) selling for different prices. This price difference is an arbitrage opportunity and will only last until the lower priced bond is bid upward. These opportunities arise when there are temporary market imperfection.
2)Intermarket Spread Swap
involve the exchange of similar bonds from two different market sectors. These sectors might be the Treasury market and the corporate market, or the Treasury market and the agency bond market. The goal of this type of swap is to capitalize on the spread between two similar bonds.
3) Rate Anticipation Swap
designed to take advantage of expected changes in market interest rates. Bond prices move inversely with interest rates. If rates are expected to increase, long-term bonds should be swapped for short-term bonds. Rising interest rates cause the value of long-term bonds to decrease more than the value for short-term bonds because long-term bonds are more sensitive to changes in interest rates. If rates are expected to decline, long-term bonds should be purchased to capitalize on the price increases for these bonds.
4) Pure Yield Pickup Swap
designed to increase the yield through a swap. This swap involves exchanging a lower YTM bond with a higher YTM bond. Typically, these bonds have very similar characteristics except for the coupon rate.
5) Tax Swap
Tax swaps are motivated by making use of unrecognized capital losses. An investor might sell a bond with a built-in capital loss for the purpose of recognizing the loss for tax purposes.
Malkiel’s Theorem
Theorem 1 Bond prices move inversely to bond yields.
Theorem 2 For a given change in yield, longer-term bond price changes are greater than changes for shorter-term bond prices.
Theorem 3 The percent change in price described in Theorem 2 increases at a diminishing rate as bond maturity increases.
Theorem 4 Price movements resulting from equal absolute (or, what is the same, from equal proportionate) increases and decreases in yield are asymmetric; i.e., a decrease in yields raises bond prices more than the same increase in yields lowers prices.
Theorem 5 The higher the coupon carried by the bond, the smaller the percentage price fluctuation for a given change in yield except for one-year securities and consols.
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Duration -Rule of thumb
multiply the percent increase (or decrease) in bond interest rate by the years of duration and this will give you the percent change in price of the bond
Financial Risk
Amount of borrowed fund or leveraging a firm utilizes to structure it investment and finance its assets.
Rational and Normal Investors
To be added
Riding the Yield curve
refers to purchase of debt instruments in anticipation of rate fluctuations on both short & long term debt.
The Constructive receipt doctrine
When income is readily available to tax payer and is NOT subject to substantial limitation or restrictions, that is income is constructively received and should be taxed.
Head of household status
unmarried person or considered unmarried on last day of the year who ,
paid more than half the cost of keeping up a home,
spouse did not live in the house during last six months,
main home for taxpayer’s child or qualifying person for more than 6 months and able to claim a credit for that child
Active income
Wages
Salary
Sch.C income
Trade or busineess income
Portfolio income
Interest
Dividend
Royalties
Annuities
