CHAPTER TWELVE Bonds: Analysis and Strategy CHAPTER TWELVE Bonds: Analysis and Strategy Cleary / Jones Investments: Analysis and Management.

Slides:



Advertisements
Similar presentations
Vicentiu Covrig 1 Bond Yields and Interest Rates (chapter 17)
Advertisements

CHAPTER FIFTEEN BOND PORTFOLIO MANAGEMENT. BOND PORTOLIOS n METHODS OF MANAGMENT Passive 3 rests on the belief that bond markets are semi- strong efficient.
Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 16 Investing in Bonds.
INVESTMENTS: Analysis and Management Second Canadian Edition INVESTMENTS: Analysis and Management Second Canadian Edition W. Sean Cleary Charles P. Jones.
The Term Structure of Interest Rates
Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Seventh Edition by Frank K. Reilly & Keith C. Brown Chapter 20.
INVESTMENTS | BODIE, KANE, MARCUS Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin CHAPTER 15 The Term Structure.
1 Chapter 16 Revision of the Fixed-Income Portfolio.
Chapter 11 Bond Valuation.
Chapter 13 Investing in Bonds Copyright © 2012 Pearson Canada Inc
Chapter 3 Structure of Interest Rates © 2001 South-Western College Publishing Company.
Managing Bond Portfolios
Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Seventh Edition by Frank K. Reilly & Keith C. Brown Chapter 20.
Managing Bond Portfolios
Bond Analysis, Portfolio Strategies, and Trade Executions AAII Washington, DC Chapter December 6, 2008 Presented by Bob Pugh, CFA President, Insight Wealth.
Managing Bond Portfolios
Chapter 6 The Risk and Term Structure of Interest Rates.
How Do The Risk and Term Structure Affect Interest Rates
Contemporary Investments: Chapter 10 Chapter 10 MANAGING BOND PORTFOLIOS What has happened to the volatility of bond prices? How does the term structure.
© 2008 Pearson Education Canada6.1 Chapter 6 The Risk and Term Structure of Interest Rates.
The Risk and Term Structure of Interest Rates
THE STRUCTURE OF INTEREST RATES
Chapter 19 FIXED-INCOME PORTFOLIO MANAGEMENT. Chapter 19 Questions What are three major bond-portfolio management strategies? What are the two specific.
Copyright © 2000 by Harcourt, Inc. All rights reserved Chapter 15 The Term Structure of Interest Rates.
The Money Market. The money market is the market for short term debt – that is, debt that matures in less than or equal to one year. The main instruments.
Bond Portfolio Management Strategies
Yield Curves and Term Structure Theory. Yield curve The plot of yield on bonds of the same credit quality and liquidity against maturity is called a yield.
Managing Bond Portfolios
Copyright  2011 Pearson Canada Inc Chapter 6 The Risk and Term Structure of Interest Rates.
Managing Bond Portfolio
Chapter 19 - Bond Portfolio Management Strategies
The risk and term structure of interest rates
The Term Structure And Risk Structure Of Interest Rates
Chapter 11 Managing Fixed-Income Investments Irwin/McGraw-hill © The McGraw-Hill Companies, Inc., 1998 Managing Fixed Income Securities: Basic Strategies.
Bonds: Analysis and Strategy
McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16 Managing Bond Portfolios.
VALUATION OF BONDS AND SHARES CHAPTER 3. LEARNING OBJECTIVES  Explain the fundamental characteristics of ordinary shares, preference shares and bonds.
1 Chapter 11 Bond Valuation. 2 Bond Valuation and Analysis Goals 1. Explain the behavior of market interest rates, and identify the forces that cause.
1 Chapter 16 Revision of the Fixed-Income Portfolio Portfolio Construction, Management, & Protection, 5e, Robert A. Strong Copyright ©2009 by South-Western,
INVESTMENTS | BODIE, KANE, MARCUS Chapter Fifteen The Term Structure of Interest Rates Copyright © 2014 McGraw-Hill Education. All rights reserved. No.
Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K. Reilly & Keith C. Brown Chapter 19.
1 Bond:Analysis and Strategy Chapter 9 Jones, Investments: Analysis and Management.
Chapter 9 Debt Instruments Quantitative Issues.
McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16 Managing Bond Portfolios.
16 Investment Analysis and Portfolio Management First Canadian Edition
Intermediate Investments F3031 Passive v. Active Bond Management Passive – assumes that market prices are fairly set and rather than attempting to beat.
Learning Goals Discuss the components that influence the risk-free interest rate at a given point in time. Explain why the risk-free interest rate changes.
1 Bond Portfolio Management Term Structure Yield Curve Expected return versus forward rate Term structure theories Managing bond portfolios Duration Convexity.
Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 6-1 Risk Structure of Interest Rates Default risk—occurs when the issuer of the bond is unable.
CHAPTER 3 Structure of Interest Rates © 2003 South-Western/Thomson Learning.
Course 4 The Risk and Term Structure of Interest Rates.
Class Business Upcoming Homework. Bond Page of the WSJ and other Financial Press Jan 23, 2003.
Fundamentals of the bond Valuation Process The Value of a Bond.
Chapter 18 - The Analysis and Valuation of Bonds.
Chapter 11 Bond Valuation. Copyright ©2014 Pearson Education, Inc. All rights reserved.11-2 For bonds, the risk premium depends upon: the default, or.
Bond Valuation and Risk
Chapter 11 Managing Bond Portfolios. Interest Rate Sensitivity (Duration we will cover in Finc420) The concept: Any security that gives an investor more.
FINANCE IN A CANADIAN SETTING Sixth Canadian Edition Lusztig, Cleary, Schwab.
INVESTMENTS: Analysis and Management Third Canadian Edition INVESTMENTS: Analysis and Management Third Canadian Edition W. Sean Cleary Charles P. Jones.
Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Seventh Edition by Frank K. Reilly & Keith C. Brown Chapter 20.
Chapter 6 The Risk and Term Structure of Interest Rates.
 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 16-1 Fixed-Income Portfolio Management Chapter.
1 FIN 2802, Spring 08 - Tang Chapter 15: Yield Curve Fina2802: Investments and Portfolio Analysis Spring, 2008 Dragon Tang Lecture 11 Bond Prices/Yields.
 Bonds-Basics  Bond Price Theorems Bond Price Theorems  Bonds-Duration & Immunization Bonds-Duration & Immunization  Bond Portfolio Mgt. Strategies.
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved Managing Bond Portfolios Chapter 16.
Bonds: Analysis and Strategy
Chapter 17 Foundations for Longer-Term Financing
Bond Yields and Prices Chapter 17
The Term Structure of Interest Rates
The Term Structure & Risk Structure Of Interest Rates
Presentation transcript:

CHAPTER TWELVE Bonds: Analysis and Strategy CHAPTER TWELVE Bonds: Analysis and Strategy Cleary / Jones Investments: Analysis and Management

Learning Objectives n To explain why investors buy bonds n To discuss major considerations in managing a bond portfolio n To explain what is meant by the term structure of interest rates n To differentiate between passive and active strategies for managing a bond portfolio n To describe how both conservative and aggressive investors build a fixed-income portfolio

Why Buy Bonds? n Attractive to investors seeking steady income and aggressive investors seeking capital gains n Promised yield to maturity is known at the time of purchase n Can eliminate risk that a rise in rates decreases bond price by holding to maturity

The Case Against Buying Bonds n Don’t hold bonds unless investing strictly for income –Capital appreciation negative n Alternative: a combination of cash investments and stocks n Investors should consider whether they could build better portfolios that do not include bonds

Buying Foreign Bonds n Why? –Foreign bonds may offer higher returns at a point in time than alternative domestic bonds –Diversification n Can be costly and time-consuming –Illiquid markets –Transaction costs and exchange rate risk

Understanding the Bond Market n Benefits from a weak economy –Interest rates decline and bond prices increase n Important relationship is between bond yields and inflation rates –Investors react to expectations of future inflation rather than current actual inflation

Term Structure of Interest Rates n Term structure of interest rates –Relationship between time to maturity and yields n Yield curves –Graphical depiction of the relationship between yields and time to maturity for bonds that are identical except for maturity n Default risk held constant

Term Structure of Interest Rates n Upward-sloping yield curve –typical, interest rates rise with maturity n Downward-sloping (or inverted) yield curves –Unusual, predictor of recession? n Term structure theories –Explanations of the shape of the yield curve and why it changes shape over time

Expectations Theory n Long-term rates are an average of current short-term rates and those expected to prevail over the long-term period –Average is geometric rather than arithmetic n If expectations otherwise, the shape of the yield curve will change n Forward rates are rates that are expected to prevail in the future

Liquidity Preference Theory n Rates reflect current and expected short rates, plus liquidity risk premiums n Liquidity premium to induce long term lending –Implies long-term bonds should offer higher yields n Interest rate expectations are uncertain

Preferred Habitat Theory n Investors have preferred maturities –Borrowers and lenders can be induced to shift maturities with appropriate risk premium compensation –Shape of yield curve reflects relative supplies of securities in each sector n Most market observers are not firm believers in any one theory

Market Segmentation Theory n Investors confine their activities to specific maturity sectors n Investors are unwilling to shift from one sector to another to take advantage of opportunities

Risk Structure of Rates n Yield spreads –Relationship between yields and the particular features on various bonds n Yield spreads are a result of –Differences in: quality, coupon rates, callability, marketability, tax treatments, issuing country

Passive Bond Strategies n Investors do not actively seek out trading possibilities in an attempt to outperform the market –Bond prices fairly determined –Risk is the portfolio variable to control n Investors do assess default and call risk –Diversify bond holdings to match preferences

n Buy and hold –Choose most promising bonds that meet the investor’s requirements –No attempt to trade in search of higher returns n Indexing –Attempt to match performance of a well known bond index –Indexed bond mutual funds Passive Bond Strategies

Active Bond Strategies n Requires a forecast of changes in interest rates –Lengthen (shorten) maturity of bond portfolio when interest rates are expected to decline (rise) n Horizon analysis –Projection of bond performance over investment horizon given reinvestment rates and future yield assumptions

n Identify mispricing among bonds, then swap –Substitution swap, pure yield pickup swap, rate anticipation swap, intermarket spread (sector) swap n Interest rate swaps –Exchange a series of cash flows –Convert from fixed- to floating-rate –Primarily used to hedge interest rate risk Active Bond Strategies

ImmunizationImmunization n Immunization is a hybrid strategy n Used to protect a bond portfolio against interest rate risk –Price risk and reinvestment risk cancel n Price risk results from relationship between bond prices and rates n Reinvestment risk results from uncertainty about the reinvestment rate for future coupon income

ImmunizationImmunization n Risk components move in opposite directions –Favourable results on one side can be used to offset unfavourable results on the other n Portfolio immunized if the duration of the portfolio is equal to investment horizon –Like owning zero-coupon bond

Building a Fixed-Income Portfolio n If conservative investor –View bonds as fixed-income securities that will pay them a steady stream of income with little risk –Buy and hold government bonds n Conservative investor should consider –Maturity, reinvestment risk, rate expectations, differences in coupons, indirect investing

Building a Fixed-Income Portfolio n If aggressive investor –View bonds as source of capital gains arising from changes in interest rates –Government bonds can be bought on margin to further magnify gains (or losses) –Seek the highest total return n International bonds –Direct or indirect investment