Topic 3 - 15.433 Investments Fixed Income BMGT 343:...

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1 15.433 Investments Fixed Income BMGT 343: Investments Prof. Anna Obizhaeva Office: VMH 4428 Phone: (301) 405-7934 Email: obizhaeva@rhsmith.umd.edu Fall 2010 Anna Obizhaeva, UMD Section 0101 T Th 9:30-10:45 am in VMH 1307 Section 0201 T Th 11:00-12:15 pm in VMH 1307 Section 0301 T Th 12:30-1:45 pm in VMH 1307 Office Hours : Wed 10:00-11:00 am or by appointment 15.433 Investments Fixed Income Fixed Income Topic 3: Yield Curves Fall 2010 Anna Obizhaeva, UMD
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2 15.433 Investments Fixed Income Recap of What We Learned So Far We started to discuss the yield curves, and how market participants use them to find the fair price of any other bonds. However, we have not talked about what factors determine the shape of the yield curve, how it changes over time and what implications it has for bond traders. Fall 2010 Anna Obizhaeva, UMD 15.433 Investments Fixed Income Outline of Topic 3 In this topic, we cover what determines the yield curve How it changes over time Fall 2010 Anna Obizhaeva, UMD
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3 15.433 Investments Fixed Income 1. Dynamics of Yield Curve See @ http://stockcharts.com/charts/YieldCurve.html Fall 2010 Anna Obizhaeva, UMD 15.433 Investments Fixed Income Shapes of Yield Curve Fall 2010 Anna Obizhaeva, UMD Interest rates are not flat and move substantially over time. The normal shape of the yield curve is upward, but, occasionally, it slopes downwards or inverts.
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4 15.433 Investments Fixed Income Why Market Participants Care About Yield Curve? The total bond return of coupon-bearing bonds , held to maturity, will depend on the future interest rates at which coupons are reinvested. 110 Even for zero-coupon bonds , market participates might be subject to the risk of changing yield curve, if they prefer to sell bonds before Cash Flow Year 10 10 12 3 0 reinvest @ new 2-year interest rate at year 1 reinvest @ new 1-year interest rate in year 2 Fall 2010 Anna Obizhaeva, UMD maturity, because their profits will depend on the prevailing at that moment bond prices (or interest rates). There is no need to care about the changes in the yield curve, only if bond position is perfectly hedged; it does not happen often. 15.433 Investments Fixed Income 2. Determinants of Yield Curve A challenging task is to understand exactly what forces are driving yields at any given time and at any given point of the yield curve. Why should bonds of differing maturities offer different yields? Fall 2010 Anna Obizhaeva, UMD
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5 15.433 Investments Fixed Income Determinants of Yield Curve (cont’d) Some often mentioned explanations (not mutually exclusive): • Investors’ expectations for future interest rates.
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Topic 3 - 15.433 Investments Fixed Income BMGT 343:...

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