Podcast
Questions and Answers
Which of the following types of bonds does not provide periodic coupon payments?
Which of the following types of bonds does not provide periodic coupon payments?
What is a limitation of using a top-down analysis approach?
What is a limitation of using a top-down analysis approach?
What is a characteristic of a Callable bond?
What is a characteristic of a Callable bond?
What is an advantage of using a top-down analysis approach?
What is an advantage of using a top-down analysis approach?
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What is the primary difference between a Treasury bond and a Municipal bond?
What is the primary difference between a Treasury bond and a Municipal bond?
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What is a limitation of using a bottom-up analysis approach?
What is a limitation of using a bottom-up analysis approach?
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What happens to the price of a bond when the coupon rate is lower than the YTM?
What happens to the price of a bond when the coupon rate is lower than the YTM?
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What is the main implication of an inverted yield curve?
What is the main implication of an inverted yield curve?
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What is the main assumption of the Liquidity Preference Theory?
What is the main assumption of the Liquidity Preference Theory?
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What is the relationship between Macaulay's Duration and YTM?
What is the relationship between Macaulay's Duration and YTM?
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What happens to a bond's price when interest rates increase?
What happens to a bond's price when interest rates increase?
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What is the main characteristic of a Premium Bond?
What is the main characteristic of a Premium Bond?
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What is the relationship between Time to Maturity (TTM) and Duration?
What is the relationship between Time to Maturity (TTM) and Duration?
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What is the implication of Modified Duration (Dmod) on a bond's price?
What is the implication of Modified Duration (Dmod) on a bond's price?
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What is the relationship between a bond's duration and its price sensitivity to interest rate changes?
What is the relationship between a bond's duration and its price sensitivity to interest rate changes?
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What is the effect of an increase in interest rates on a bond's duration?
What is the effect of an increase in interest rates on a bond's duration?
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What is the purpose of convexity in bond analysis?
What is the purpose of convexity in bond analysis?
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What is the relationship between a bond's convexity and its duration?
What is the relationship between a bond's convexity and its duration?
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Which of the following statements about convexity is true?
Which of the following statements about convexity is true?
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What is the implication of higher convexity for an investor?
What is the implication of higher convexity for an investor?
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Study Notes
Top-Down Analysis vs. Bottom-Up Analysis
- Top-Down Analysis: starts with the overall economy and gradually focuses on a specific company, providing a comprehensive holistic view of the market and macroeconomic factors.
- Strengths: incorporates industry trends, economic factors, and market dynamics into valuation models, saves time by looking at broader market trends.
- Weaknesses: may overlook firm-specific factors, highly sensitive to changes in economic conditions.
- Bottom-Up Analysis: starts with a specific firm/company and gradually looks at the overall economy, providing a comprehensive analysis of individual companies.
- Strengths: focuses on firm-specific fundamentals, competitive positioning, growth aspects, and financial performance.
- Weaknesses: takes more time, may have delays in missing out on returns.
Bonds
- Raise long-term capital issued by corporations and governments.
- As an investor, you pay the initial cost (price) and receive coupon (interest) periodically, and the face value of the bond when it matures.
- Types of bonds:
- Convertible bonds: can be converted into a predetermined number of stocks in the future.
- Indexed bonds: rate of return is eroded by inflation, coupon is related to movements in inflation.
- Callable bonds: the seller can buy the bond back from you in the future.
- Perpetual bonds: last forever.
- Treasury bonds: issued by the federal government.
- Municipal bonds: issued by state government or government agencies.
Bond Characteristics
- Par Value Bond: coupon rate = YTM (yield to maturity).
- Discount Bond: coupon rate is less than YTM, sold at a price below face value.
- Premium Bond: coupon rate is greater than YTM, sold at a price above face value.
Bond Risks
- Price Risk: occurs when interest rates go up, investors are subject to price risk if they need to sell before maturity, good for investors if yields decrease, and bad if yields increase.
- Inflation Risk: causes bond prices to decrease, ultimately decreasing the return of bonds, if subject to price risk.
- Liquidity Risk: suffers loss if desperately need to sell the bond before maturity, won't be able to liquidate the bond at a reasonable price if yields are high and the price has dropped.
Yield Curve
- Normal (Upward-Sloping): short-term yields are lower than long-term yields, long-term bonds have higher yields, suggests stronger economic growth and potentially higher inflation in the future.
- Inverted (Downward-Sloping): short-term bonds have higher yields compared to long-term bonds, suggests slower economic growth or a recession in the future.
Duration and Convexity
- Macaulay's Duration: measures the sensitivity of a bond's price to changes in interest rates, looking at price risk, increases as TTM goes up.
- Properties:
- Dmac is less than or equal to TTM.
- Dmac is higher for bonds with lower Crate (all else equal).
- Dmac is higher for bonds with lower YTM (all else equal).
- Dmac is higher for bonds with higher TTM (all else equal).
- Modified Duration: a modified version of Dmac adjusting for the bond's yield, represents a percentage change in a bond price.
- Implications of Duration:
- Positive relationship between a bond's duration and price sensitivity to interest rate changes.
- Positive relationship between TTM and duration.
- Negative relationship between the coupon rate and duration.
- Convexity: measures the sensitivity of a bond's duration to changes in interest rates, captures the non-linear relationship between a bond's price and yield.
- Properties:
- Convexity is higher for bonds with lower Crate (all else equal).
- Convexity is higher for bonds with lower YTM (all else equal).
- Convexity is higher for bonds with higher TTM (all else equal).
- Summary of Duration and Convexity:
- Duration and Convexity have a positive relationship.
- Convexity is good, gives more gains when yields decrease and less losses when yields increase.
- Duration is not good, when duration increases, you have more interest rate risk, when duration decreases, you have less interest rate risk.
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Description
Learn about the top-down approach in finance, which involves analyzing the overall economy and market trends before focusing on a specific company. This approach provides a comprehensive view of the market and macroeconomic factors, but may overlook firm-specific factors.
