Ch11_Kim_BKM_INV_7th - Bodie Kane Marcus Essentials of...

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Essentials of Investments Bodie • Kane • Marcus Chapter 11 Managing Bond Investments
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Essentials of Investments Bodie • Kane • Marcus Managing Fixed Income Securities: Basic Strategies Active strategy Active managers attempt to achieve abnormal returns, which are more than commensurate with the risk borne. Use interest rate forecasts to predict the movements in the fixed-income market. Employ inter-market analysis to identify relatively mispriced fixed-income securities or sectors. Passive strategy Securities are fairly priced in the market. Rather than attempting to outperform the market by exploiting superior information or insight, passive managers act to maintain appropriate risk-return balance given market opportunities.
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Essentials of Investments Bodie • Kane • Marcus Interest Rate Risk Interest rate risk: The risk of a decline in a bond’s price due to an increase in interest rates. Bond prices and yields are inversely related. As yields increase (decrease), bond prices fall (rise). An increase in a bond’s YTM results in a smaller price decline than the price gain associated with a decrease of equal magnitude in yield. Decreases in yields have bigger impacts on price than increases in yields of equal magnitude. Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds.
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Essentials of Investments Bodie • Kane • Marcus Interest Rate Risk Interest rate risk is less than proportional to bond maturity. The sensitivity of bond prices to changes in yields increases at a decreasing rate as maturity increases. Interest rate risk is inversely related to the bond’s coupon rate. Prices of high-coupon bonds are less sensitive to changes in interest rates than prices of low-coupon bonds The sensitivity of a bond’s price to a change in its yield is inversely related to the YTM at which the bond is currently selling.
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Essentials of Investments Bodie • Kane • Marcus Change in Bond Price as a Function of YTM
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Essentials of Investments Bodie • Kane • Marcus Interest Rate Risk Maturity alone is not sufficient to measure interest rate sensitivity. Bond characteristics such as coupon rate or YTM affects interest rate sensitivity. The times to maturity are not perfect measures of the long- or short-term nature of the bonds. Given time-to-maturity, the price of a zero-coupon bond are more sensitive to changes in interest rate than a coupon bond A zero-coupon bond represents a longer term investment than an equal-time-to-maturity coupon bond Longer Effective Maturity Need for a Measure of Effective Maturity .
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Essentials of Investments Bodie • Kane • Marcus Duration Effective Maturity A coupon bond can be viewed as a portfolio of coupon payments and principal Each payment may be considered to have its own maturity date The effective maturity should be an average of the maturities of all the cash flows paid out by the bonds.
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