| All of the above | | The higher the relative risk level, the lower the demand of that asset. Chapter 8: Risk & rates of Return Summary A flat yield curve is where longer term maturity bonds and shorter term maturity bonds are close to each other. | Which of the following statements is true? b). An upward-sloping yield curve: Term. Start studying Finance Chapter 6 terms. The aim of this paper is to discuss recent developments in interest rate term structure modeling and the application of these models to the interest rate risk management and valuation of cash ﬂows that are dependent on future interest rates. What are the Fundamental Bond Pricing Properties? Repo dealer A normal yield curve is one in which longer-termed maturities have higher interest rates. Your boss has developed the following set of questions which you must ask and answer to explain the U.S. financial system to Dellatorre. By the end of this chapter, you should be able to: 3. When the yield curve is flat, then it generally indicates a slow down in the economy so investors are not being compensated for the risk of taking on longer term bonds. Bond yields or interest rates are plotted against X-axis while time horizons are plotted on Y-Axis. | - | | * You only pay the amount required to make your total tax rate your personal theory that investors prefer short-term debt securities over long-term and, therefore, demand a higher yield (risk premium) when purchasing long-term debt securities. | | 2. it involves long and short positions of similar instruments. Date: Markets for physical assets（财产，有利条件）: Buying a stock makes you one of the owners of a corporations and buying a bond makes you one of the lenders. A) increase; reduce B) reduce; reduce C) increase; not affect D) reduce; increase E) increase; increase 5) Bonds with relatively low risk of default are called A) investment grade bonds. Be sure you know how to calculate any given components with given supporting information. 1. 7 Yields generally tend to move in line with maturity, producing an upward sloping yield curve or a “normal yield curve.” Rarely, however, the yields on the long-term treasuries fall below the yields of short-term treasuries. © CSI GLOBAL 7•2 EDUCATION INC. (2011) C) default premium. | 13 | | We will look at the behavior of interest rates of two groups of bonds: (1) Bonds with the same features but are issued by different agency. 4) An increase in the riskiness of corporate bonds will _____ the yield on corporate bonds and _____ the yield on Treasury securities. 1. * Franking (imputation) credit: Dividends paid have a credit attached for tax paid by the corporation Principles of Finance BS120 Tutorial Week 4: Topic Risk and Term-Structure of Interest Rates Issues Considered * Risk-free Rate. Money markets are markets where money is borrowed for short time periods, usually less than a year. | | 3. * Shareholders: Own the Corp, but have no say in daily operations I will do so by explaining the importance of understanding the term structure, as well as the three theories that support the term structure; the expectations theory, the segmented markets theory, and the liquidity premium theory. * Risk Premiums * Bond ratings * Yield Curves: normal, inverse, humped * Three theories of the yield curve: - The Pure-Expectations Theory of the Yield Curve. ...The Financial Environment: | | 5. 1. Once the newly issued on-the-run bonds become off-the run, the yields on the two bonds converge and LTCM makes a profit. * Sole proprietorship * Partnership * Limited liability company * Corporation | * Sole traders * Partnerships * Trusts * Companies | ------------------------------------------------- So rationally, an investor would expect higher compensation (yield), thus giving rise to a normal positively sloped yield curve. A parallel shift in the yield curve neither flattens nor steepens the yield curve. • Calculating Accrued Interest Risk in a portfolio context (8-3) How are Price and Yield of a Bond Calculated? You Face value of 1-year bond= 1MM*0.317%=1003170 - Liquidity Premium Theory of the Yield Curve. MD(1)=1/1.00317=0.9968, if delta y=1%, delta B/B= -0.9968% $12220 The different yields currently available on debt securities of similar credit quality according to their term-to-maturity, typically represented graphically. If a firm...... ...Yield Curve and Bond Valuation 3. 802797-797700= $5097 increase • Calculating the Current Yield on a Bond What is the Term Structure of Interest Rates? • Global Indexes Contents 4. Answer: Essay. Again a market is a transaction, not a physical location. CHAPTER OUTLINE 3) Other things being equal, an increase in the default risk of corporate bonds shifts the demand curve for corporate bonds to the _____ and the demand curve for Treasury bonds to the _____. subject: fair value hierarchy 1. interest rate environment in which short-term debt securities yield more than intermediate and long-term securities. Yield-curve risk, also known as interest-rate risk, is the risk of interest rate changes affecting bond prices. What can cause an inverted/negative yield curve? Risk structure of interest rate As we have discussed in the previous section, the (relative) risk level of an asset affects its demands according to the theory of asset demand. A yield curve is typically upward sloping; as the time to maturity increases, so does the associated interest rate. FFC measures the derivative at fair value, presenting the portion of the fair value change by using the fair value hierarchy. Assume that you recently graduated with a degree in finance and have just reported to work as an investment advisor at the brokerage firm of Balik and Kiefer Inc. One of the firm’s clients is Michelle Dellatorre, a professional tennis player who has just come to the United States from Chile. | | 5. (122.2018*(1+0.02/360)-118.1528)*100= $405.58 This paper surveys the main concepts and techniques of recent developments in the modeling of the term structure of interest rates that are used in the risk management and valuation of interest-rate-dependent cash ﬂows. 100 bonds CONTENTS D) risk premium. A humped yield curve is where yield increases for a range of maturities and then decreases. These ideas were pioneered in the actuarial profession by the British actuary Frank Redington (1952). These developments extend the concepts of immunization and matching to a stochastic interest rate environment. | | 4. Corporate Ownership versus Control The annual payments are $6,202.70. Such cash ﬂows include the cash ﬂows on assets such as bonds and mortgage-backed securities as well as those for annuity products, life insurance products with interest-rate-sensitive withdrawals, accrued liabilities for deﬁnedbeneﬁt pension funds, and property and casualty liability cash ﬂows. | - | | | - | | Corporations | 19 | | * Legal entity separate from its owners must be legally formed life of the bond). ...Memorandum Introduction 8 If you think about it intuitively, if you are lending your money for a longer period of time, you expect to earn a higher compensation for that. (2) Bonds issued by the same agency but have different term to maturity (i.e. * Board of Directors: These are markets where financial assets sold and bought. when there was a specifiable future date(usually medium-term fixed maturities) by which convergence of offsetting short and long positions in similar instruments should occur. 6. 1. | The present value of a single future sum: | 1. 1. date: december 15, 2012 4. * For $1 dividends, company must earn $1.4286 @ 30% company tax rate The "Liquidity preference". What does the interest rates shape change from 2001 to 2010 mean? Chapter 6: Interest Rates Bond value when zero-curve shifts up by 1% = 5/1.015+5/1.0155^2+5/1.0165^3+5/1.0175^4+5/1.02^5+5/1.0225^6+5/1.025^7+105/1.0255^8= $118.1528 1.1 Overview : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : 1.2 The Instruments : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : Instrument 1 —Collateralized Debt Obligation Here the loans are used mainly to manage cash in a corporation. In other words, it is cheaper to borrow short-term or long-term than it is to borrow intermediate-term. Here's an example. 4. a. | The theoretically logical and operationally feasible normative goal for guiding financial decision making is | 1. This memo will present the appropriate classification in the fair value hierarchy for each investment and provide appropriate authoritative guidance to support the determination. However, the yield curve can be inverted and downward-sloping if the economy is expected to slow or a recession is imminent. Flat (Humped) Yield Curve. * Company earning for $1 dividend income: gross dividend=div1-tc | 1 | In other words, we want to look at the risk structure of interest rates. Chapter 7: Bond Valuation NEW! i ...Working Draft: No Guarantees August 27, 1998 Home page: http: www.stern.nyu.edu ~dbackus This creates an inverted yield curve. * Tax implications She also expects to invest substantial amounts of money through Balik and Kiefer. Determinants of market interest rates (section 6-3) Since this part of the course deals with different types of markets, let us start by defining what these markets are. * Double taxation in the US (only concerned with ‘C’ corporations) Defi ne present value and the discount rate, and perform calculations relating to the time value of Using the yield curve to predict interest rates (section 6-6) | | 5. Why is the yield curve upward sloping in 2010? The shape of the yield curve changes over time as interest rates change in the marketplace. * Ultimate decision-making...... ...Chapter 1 2. Dellatorre is also very bright, and, therefore, she would like to understand, in general terms, what will happen to her money. A humped yield curve is only a somewhat rare occurrence. Why is a yield curve generally positively sloped? What is the definition of Liquidity preference? | | E) All of the above are true statements. a). Commonly there are three kinds of Yield Curves that are observed in the financial markets. Whenever you exchange something for another you have a market. Market value of portfolio= 1MM-0.2023MM=797700 Plotting the points on the basis of the data’s of interest rate and terms to maturity, the yield curve is drawn. 4.1 Price and Yield : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : 4.2 More on Duration : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : 4.3 Immunization : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : 4.4 Convexity optional : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : 4.5 Fixed Income Funds : : : : : : : : : : : : : : : : :...... ...maturities can have different interest rates. An Overview of Corporate Finance and B) capitalized risk. 3. | Your company has received a $50,000 loan from an industrial finance company. 100% of the time (since 1986 at least) after the yield curve took on a humped shape, stocks eventually fell quite a lot, but with a variable lead time. | increases as the number of discount periods increases. In addition to these notes, please read chapter 3 and pages 191 through 206 of chapter 5. • Calculating the Yield to Maturity on a Bond Assessing a bond’s risk (7-7) An inverted yield curve would suggest that A. interest rates are expected to rise. Royal Dutch and Shell). | is generally larger than the future sum. 7) An increase in the liquidity of corporate bonds will _____ the price of corporate bonds and _____ the yield of Treasury bonds. 3 Macrofoundations of Interest Rates Generally, a flat curve is temporary in nature and indicates uncertainty in the market place as to what direction the fed will take. MD = -(118.1528-126.4236)/(2*0.01)*(1/122.2018)= 3.3841 Analyze the impact of fi xed-income pricing properties on bond prices. Hump shaped yield curve and liquidity premium theory - YouTube These are markets where tangible（有形的） assets, things you can touch are exchanged for money. Examples of financial assets include stocks （股票，存货）and bonds（债券）. • The Impact of Yield Changes Possibly because personally I’m a bit deep into bonds, not many would agree with the second part though. The reason for that is that debt issued for a longer term generally carries greater risk because of the greater likelihood of inflation or default in the long run. Face value of 5-year bond= 0.2023MM*1.479%=217727 1. | dividend maximization | | | With perfect negative correlation, the risk on a portfolio can be zero if an appropriate allocation of funds is made | 1 | * Australian company tax rate: τc=30% Please note that this is only a study guide and should not be taken as the actual content of your second exam. LTCM engaged in primarily in convergence and relative value strategies. * Ownership represented by shares of stock, sum of which is OE * Shareholders compute tax at their own tax rate (τp) based on the corporation’s pre-tax income, then subtract the tax paid at the corporate level 1 2 yield curve from normal to inverted or vice versa. Bond value when zero-curve shifts up by 1% =$118.1528 Upward sloping B. How does Bond Market Trading Work? *In addition please review the Cengage assignments & Team application activities that apply to the above chapters. What are Bond-Switching Strategies? Delta B/B= -3.3841*0.01+1/2*14.1405*0.01^2= -0.033 | | 2. | | 3. What determines the shape of a yield curve (section 6-5) determination. © CSI GLOBAL EDUCATION INC. (2011) 7•3 C) As their relative riskiness increases, the expected return on corporate bonds decreases relative to the expected return on default-free bonds. However, there are many types of bonds: bonds with different maturity, bonds issued by different parties (i.e. | increases as the discount rate increases. • The Real Rate of Return According to Hubbard and O’Brien, the term structure “is the relationship among the interest rates on bonds that are otherwise similar but have different maturities.” Term structure is most commonly analyzed by looking at the Treasury yield curve, which is the relationship of interest rates on Treasury bonds with different maturities on a particular day. • The Relationship Between Bond Prices and Interest Rates Market Markets, Institutions, and Interest Rates A yield curve where interest rates on medium-term maturities are higher than rates on both short-and long-term maturities: Term "Normal" Yield Curve: Definition. c). These three kinds of yield curve comprise of a normal shaped yield curve, an inverted yield curve and a flat yield curve. By buying a financial asset you become an owner of a company or a lender to one. Fixed-Income Securities: In this section, we will focus on only 3 of them: default risk, liquidity, and...... ...© CSI GLOBAL EDUCATION INC. (2011) 7•1 The exchange could be goods for goods, goods for service, or goods and services for money. | - | | What are markets in general? 1. * Corporate tax rate is 34% This is a simple strategy and not necessarily a risky trade since it is very likely that the yields will converge once the on-the-run bonds become off-the-run. The normal yield curve reflects higher interest rates for 30-year bonds, as opposed to 10-year bonds. D) The expected return on corporate bonds decreases as default risk increases. Let's say that on Jan. 2, a two-year note is at 2%, and a 10-year note is at 3%. v 1 As a result, there is a different interest rate for each type of bond. The Financial Environment According to a class lecture, six times when the yield curve became inverted, there was an economic recession. 9 | | 3. • Canadian Bond Market Indexes Relative value strategy : It is a spread trade and it involves two assets whose prices or yields tend to converge with time . $12220 Since the yield spread between on- and off-the-run bonds is very narrow, it is possible to make significant profits only with large positions. Lecturer: A yield curve is a way to easily visualize this difference; it's a graphical representation of the yields available for bonds of equal credit quality and different maturity dates. 1. Because the interest rates do not change in the same amount of percentages, the yield curve is steeper. ...Chapter 6 Rate The Risk and Term Structure of Interest In the previous section, we have generalized our discussion of the influence of various factors on the behavior in interest rate by examining only a particular type of bonds: namely, the 1-year zero coupon bond. 2. 4. |...... ...INTEREST RATE RISK MANAGEMENT: DEVELOPMENTS IN INTEREST RATE TERM STRUCTURE MODELING FOR RISK MANAGEMENT AND VALUATION OF INTEREST-RATE-DEPENDENT CASH FLOWS Analysis Markets are transactions where individuals or organizations exchange items. net shareholder tax=div1-τc*(τP-τC) What is a yield curve? If the company is paying 9% interest per year, how many loan payments must the company make? Why is corporate finance important to all managers? 2 Bond Arithmetic Four Types of Firms US | Four Types of Firms AUS | Humped or Flat yield curve – no one knows what economy will do . The fair value measurement of the Collateralized Debt Obligation investment shall be categorized within Level 3 of the fair value hierarchy. The rates were picked from the current dates (1st January2012) back to five years a go (1st January 2007). | | 4. Convergence Strategy: In case of convergence strategy the two asset prices or yields must converge. | 1. MD(5) = 5/1.01479= 4.9271, if delta y=1%, delta B/B=-4.9271% ------------------------------------------------- B. interest rates are expected to fall. What is the market predicting about the future of short-term interest rates if the yield curve is: (a) upward sloping, (b) downward sloping, (c) humped? LEARNING OBJECTIVES government vs. corporate), etc. 5. Bonds with semi-annual coupons (7-6) | The degree of risk reduction for a portfolio depends only on the number of securities in the portfolio | | Markets for financial assets: 3. | In cases of zero correlations between the assets, risk can be fully eliminated through diversification | | a. The yield curve flattens—that is, it becomes less curvy—when the difference between yields on short-term bonds and yields on long-term bonds decreases. 100 bonds What are Bond Indexes? Relationship between risk and rate of return (8-4) Andrew Ang* and Michael Sherris† Now, let us look at the different types of markets: In other words, we want to look at the term structure of interest rates. There are a number of factors that affect the risk level of a bond. • The Impact of Maturity Since 1986 the yield curve has had some measure of humpedness 25% of the time. Explain the way in which the default risk and illiquidity premium affect the price of corporate bonds. | depends upon the number of discount periods. Investors demand higher interest when lending their money for longer periods. Term Structure 5. Everybody sells the short-term debt in order to buy the long-term debt. | 12 | 3 | The time to maturity is smaller. • The Yield Curve It is therefore prudent to expand your preparation beyond this... ...Part 1 Based on the information retrieved from the Board of Governors of the Federal Reserve System on a 1-month business day, the following information concerning historical dairy interest rates on the U.S treasury was obtained. A parallel shift in the yield curve is when interest rates across all maturities change by the same number of basis points. • Duration as a Measure of Bond Price Volatility This stands true for securities with longer maturities that have greater risk exposure as opposed to short term securities. What is an inverted yield curve/negative yield curve? Answer: Corporate finance provides the skills managers need to: (1) identify and select the corporate strategies and individual projects that add value to their firm; and (2) forecast the funding requirements of their company, and devise strategies for acquiring those...... ...different trading strategies of LTCM Explain the rationale for bond switching and describe bond-switching...... ...Q.No. C) zero coupon bonds. | | Bond yields (7-7) Problems 5-18 through 5-23 of chapter 5 are related to this topic. 1. Whereby, if that date was not a business date the preceding date was selected as shown in the table below. However, other technical factors such as lower supply of long-term bonds or an increased demand for long-term bonds may cause a humped yield curve. If interest rates have been high but are expected to drop. Although the price may not completely converge, but the premium tends to narrow over time. • Calculating the Yield on a Treasury Bill I Instruments with Fixed Payments * Dividend imputation in Australia (franking credits) 4 Quantifying Interest Rate Risk Preface 1 Debt Instruments Humped Yield Curve: Definition. 4. 2. 2.1 Prices and Yields in the US Treasury Market : : : : : : : : : : : : : : : : : 2.2 Replication and Arbitrage : : : : : : : : : : : : : : : : : : : : : : : : : : : : 2.3 Day Counts and Accrued Interest : : : : : : : : : : : : : : : : : : : : : : : : 2.4 Other Conventions : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : 2.5 Implementation Issues : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : 2.6 Common Yield Fallacies : : : : : : : : : : : : : : : : : : : : : : : : : : : : : 2.7 Forward Rates optional : : : : : : : : : : : : : : : : : : : : : : : : : : : : Implications for corporate managers & investors (8-6) Studies have shown that there have been three factors that affect Treasury returns: (1) change in the level of yield, (2) changes in the slope of the yield curve, and (3) changes in the curvature of the yield curve. Investors demand higher interest when lending their money for longer periods. money, bond pricing and yield. 39 from: Daisy | | 3. 3. 1MM* -0.9968%= 5-year bond value *-4.9271% On Feb. 1, the two … Pricing and Trading ------------------------------------------------- Pricing and Trading Flat Yield Curve: Flat yield curves exist when shorter and longer-term yield rates are very close to one another. Bond value = 5/1.01+5/1.0105^2+5/1.0115^3+5/1.0125^4+5/1.015^5+5/1.0175^6+5/1.02^7+105/1.0205^8 = $ 122.2018 Defi ne a real rate of return and a yield curve, and evaluate three theories of interest rate The following analysis for classification of each instrument will be based on SFAS 157, which provides a hierarchy of the three-level inputs to the valuation techniques that can be used to measure fair value. Learn vocabulary, terms, and more with flashcards, games, and other study tools. This creates a rounded or humped curve. Humped yield curves are a sign of economic transition, and could indicate slowed economic growth. Yield curves are usually upward sloping asymptotically: the longer the maturity, the higher the yield, with diminishing marginal increases (that is, as one moves to the right, the curve flattens out).. Yield Curve and Bond Valuation Practice problems: 7-1, 7-2, 7-3, 7-4, 7-5, 7-8, 7-9, 7-16 Relative value strategy: it is possible to make significant profits only with large positions bonds... Bond ’ s of interest rate for each investment and provide appropriate authoritative guidance to the... Actuary Frank Redington ( 1952 ) 8-3 ) 3 demand higher interest when lending their for... Clearing and Settlement • Calculating Accrued interest © CSI GLOBAL EDUCATION INC. ( 2011 7•3. Explain the way in which short-term debt securities yield more than humped yield curve quizlet and long-term yields and prices on term! More with flashcards, games, and evaluate three theories of interest rate changes bond... Words, we want to look at the term structure of interest rates for 30-year bonds but! Term to maturity, the yields on long-term bonds yield more than holding. And evaluate three theories of interest rates are very close to one another Capital and the rate! At 2 %, and could indicate slowed economic growth explanations for sloping... Asset prices or yields tend to converge with time become off-the run, the yield of Treasury.! Between the assets, risk can be inverted and downward-sloping if the company make if interest rates are plotted X-axis., games, and could indicate slowed economic growth curve is when interest rates are plotted on Y-Axis of. | all of the lenders what these markets are transactions where individuals or organizations exchange items we want look. Not many would agree with the second part though are markets where money borrowed. 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