Lecture 12 Flashcards Preview

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Flashcards in Lecture 12 Deck (22)
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1
Q

Term structure of interest rates =

A

Structure of interest rates for discounting cash flows of different maturities

2
Q

Yield curve displays

A

Relationship between yield and maturity > plots YTM as a function of time to maturity

3
Q

Yield curve implies

A

Information on the expected future short term rates

4
Q

Bonds of different maturities sell at

A

Different yield to maturities

5
Q

Long term bonds sold at

A

Higher yields than short term bonds

6
Q

As interest rates increase/ decrease, bondholders experience

A

Capital gains/ losses

7
Q

If the market rate falls below the coupon rate

A

The bond is attractive, therefore investors would pay > the par value

8
Q

If the market rate exceeds the coupon rate

A

Investors will pay below the par value

9
Q

Duration is a measure of

A

The average maturity of a bond’s promised cash flows. The number of years required to recover the true cost (price) of the bond.

10
Q

Duration is a guide for

A

The sensitivity of a bond to interest rate changes

11
Q

Duration =

A

The weighted average of times until each payment is received. Weights are proportional to the present value of each payment.

12
Q

Duration is shorter than the maturity for

A

All bonds, except zero coupon bonds (= for zero coupon)

13
Q

Long term bonds more sensitive to interest rate movements

A

Than short term. Duration quantifies this

14
Q

Duration rules (5)

A
  • Duration of zero-coupon bond = time to maturity
  • Holding maturity constant, a bond’s duration is higher when the coupon rate is lower
  • Holding the coupon rate constant, a bond’s duration increases with time to maturity
  • Holding other factors constant, the duration of a coupon bond is higher when the bond’d YTM is lower
  • Duration of a level perpetuity = (1 + y) / y or 1 + (1/y)
15
Q

Duration is an independent coupon rate only for

A

Perpetuities

16
Q

Is there a linear relationship between bond prices and yield, as duration suggests?

A

No

17
Q

Duration rule is a good approximation when

A

There are only small changes in bond yields

18
Q

Bonds with greater convexity have

A

Increased curvature in the price-yield relationship

19
Q

Duration approximation (straight line) always

A

Understates the value of the bond
Underestimates the increase in bond price when yield falls
Overestimates the decline in the price when the yield increases

20
Q

Bonds with increased convexity see

A

Greater price increase and smaller price fall when interest rates fluctuate by large amounts

21
Q

If interest rates are volatile

A

Investors prefer convexity

22
Q

For greater convexity, investors must

A

Pay higher prices and accept lower yields to maturity