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Understanding Bond Yields and Market Expectations Study Guide

This guide provides a comprehensive overview of financial risk and return. It covers key metrics for measuring investment performance such as Holding Period Return (HPR), Effective Annual Rate (EAR), and Annual Percentage Rate (APR). The guide delves into advanced concepts like continuous compounding, scenario analysis for estimating expected returns, and statistical measures of risk including variance and standard deviation. It further explores risk premia, the Sharpe Ratio for risk-adjusted pe

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Introduction to Financial Markets and Asset Classes

Treasury, Corporate, and International Bond Markets

This topic covers Treasury notes and bonds, corporate bond types, preferred stock, international bonds, and bond pricing mechanisms including accrued interest and yield calculations.

  • Treasury notes
  • Treasury bonds
  • Callable bonds
  • Convertible bonds
  • Put bonds
  • Floating-rate bonds
  • Preferred stock
  • Foreign bonds
  • Eurobonds
  • Inverse floaters
  • Asset-backed bonds
  • Catastrophe bonds
  • Indexed bonds
  • Treasury Inflation Protected Securities (TIPS)
  • Accrued interest
  • Invoice price
  • Yield to call (YTC)
  • Yield to maturity (YTM)
  • Realized compound return
  • Horizon analysis

Introduction to Financial Markets and Investment

An overview of the roles of financial markets, the investment process, market competition, and the various players within the economy.

  • Informational role of financial markets
  • Consumption timing
  • Allocation of risk
  • Separation of ownership and management
  • Agency problems
  • Corporate governance
  • Corporate ethics
  • Sarbanes–Oxley Act
  • Asset allocation
  • Security selection
  • Security analysis
  • Top-down approach
  • Bottom-up approach
  • Risk–return trade-off
  • Efficient market hypothesis
  • Passive management
  • Active management
  • Primary market
  • Secondary market
  • Financial intermediaries

U.S. Household and Domestic Net Worth

Tables present the balance sheet of U.S. households and domestic net worth including real assets, financial assets, liabilities, and net worth.

  • Real assets
  • Financial assets
  • Liabilities
  • Net worth
  • Real estate
  • Consumer durables
  • Deposits and money market shares
  • Life insurance reserves
  • Pension reserves
  • Corporate equity
  • Mutual fund shares
  • Debt securities
  • Commercial real estate
  • Residential real estate
  • Equipment & intellectual property
  • Inventories

The 2008 Financial Crisis and Housing Finance

An analysis of the 2008 financial crisis, including antecedents, changes in housing finance through securitization, mortgage derivatives, and the Dodd-Frank Reform Act.

  • Financial Crisis of 2008
  • Securitization
  • Mortgage pass-through securities
  • Conforming mortgages
  • Subprime loans
  • Collateralized debt obligations (CDOs)
  • Tranches
  • Credit default swaps (CDS)
  • Systemic risk
  • Dodd-Frank Reform Act

Asset Classes and Money Market Instruments

This lecture covers asset allocation, financial markets, and various money market instruments including Treasury Bills, Certificates of Deposit, and repurchase agreements.

  • Asset allocation
  • Security selection
  • Money markets
  • Capital markets
  • Treasury Bills
  • Bid-ask spread
  • Certificates of Deposit
  • Commercial paper
  • Bankers' acceptance
  • Eurodollars
  • Repurchase agreements
  • Federal funds
  • Brokers' calls
  • LIBOR
  • Secured Overnight Financing Rate (SOFR)
  • Money market funds

Financial Assets and the Bond Market

The bond market is composed of longer-term borrowing or debt instruments including Treasury notes, Treasury bonds, mortgage securities, federal agency debt, municipal bonds, and corporate bonds.

  • Treasury notes
  • Treasury bonds
  • Inflation-protected treasury bonds (TIPS)
  • Federal agency debt
  • Eurobond
  • Municipal bonds
  • General obligation bonds
  • Revenue bonds
  • Industrial development bonds
  • Corporate bonds
  • Secured bonds
  • Unsecured bonds (debenture)
  • Subordinated debentures
  • Callable bonds
  • Convertible bonds
  • Mortgage-backed securities
  • Asset-backed securities
  • Conforming mortgages
  • Subprime mortgages

Equity Securities and Derivative Markets

An overview of equity securities, stock market indexes, and derivative markets including options and futures contracts.

  • Common stock
  • Residual claim
  • Limited liability
  • Dividend yield
  • Capital gains
  • Price-earnings ratio
  • Preferred stock
  • American Depository Receipts (ADRs)
  • Dow Jones Industrial Average (DJIA)
  • Standard & Poor's 500 (S&P 500)
  • Index Fund
  • Exchange-Traded Funds (ETF)
  • Derivative asset
  • Call option
  • Put option
  • Futures contract
  • Long position
  • Short position

Bond Pricing, Yield Curves, and Risk Analysis

Default Risk and Bond Pricing

This content examines default risk, credit ratings, financial ratios, yield to maturity, and the term structure of interest rates.

  • Default risk
  • Credit risk
  • Investment grade bonds
  • Speculative-grade bonds
  • Leverage ratios
  • Profitability ratios
  • Cash flow-to-debt ratio
  • Promised YTM
  • Expected YTM
  • Default premium
  • Credit spread
  • Term structure of interest rates
  • Yield curve
  • Bond stripping
  • Bond reconstitution

Bond Pricing and Yield Curve Analysis

This content covers valuing coupon bonds and zero-coupon bonds, analyzing pure and on-the-run yield curves, and calculating spot rates, short rates, and forward rates.

  • Zero-coupon bonds
  • Coupon bonds
  • Yield to maturity
  • Pure yield curve
  • On-the-run yield curve
  • Spot rate
  • Short rate
  • Holding-period returns
  • Forward rates

Theories of Term Structure and Yield Curves

Theories of the term structure explain how yield curves reflect expectations of future short rates, liquidity premiums, and market segmentation.

  • Expectations Hypothesis Theory
  • Liquidity Preference Theory
  • Market Segmentation Theory
  • Liquidity Premium
  • Forward Rate
  • Yield Curve
  • Interest Rate Uncertainty
  • Term Structure of Interest Rates

Risk, Return, and the Historical Record

Present tools for estimating expected returns and risk from the historical record including holding period return, effective annual rate, annual percentage rate, and continuous compounding.

  • Holding period return
  • Effective annual rate (EAR)
  • Annual percentage rate (APR)
  • Continuous compounding
  • Zero-coupon bond
  • Compound interest
  • Risk-free investments
  • Scenario analysis

Interest Rates and Inflation Rates

Fundamental factors determine the level of interest rates, including the relationship between nominal interest rates, real interest rates, and the expected rate of inflation.

  • Supply of funds from savers
  • Demand for funds from businesses
  • Monetary and fiscal policy
  • Expected rate of inflation
  • Nominal interest rate
  • Real interest rate
  • Purchasing power
  • Fisher hypothesis
  • Tax liabilities
  • After-tax return
  • T-Bills

Risk, Return, and Probability Distributions

This topic covers holding period returns, expected returns, standard deviation, risk premiums, and measures of downside risk and normality.

  • Holding period return (HPR)
  • Expected returns
  • Variance
  • Standard deviation
  • Risk premium
  • Excess return
  • Risk aversion
  • Sharpe ratio
  • Normal distribution
  • Skewness
  • Kurtosis
  • Value at risk (VaR)
  • Expected shortfall (ES)
  • Lower partial standard deviation (LPSD)
  • Sortino Ratio

Risk, Return and Value at Risk

This topic covers lognormal distribution, return averages, and the calculation of Value at Risk using normal distribution and the square root of time rule.

  • Lognormal distribution
  • Continuously compounded returns
  • Arithmetic average
  • Geometric average
  • Expected return
  • Variance
  • Standard deviation
  • Sharpe ratio
  • Real rate of return
  • Value at Risk (VaR)
  • Quantile
  • Cumulative distribution function (cdf)
  • Normal distribution
  • Square root of time rule
  • Daily earnings at risk (DEAR)

Risk and Return Historical Records

Learning from historical returns using arithmetic average return, geometric average return, variance, and standard deviation to analyze investment risk and performance.

  • Geometric average return
  • Holding period total return
  • Time-weighted average return
  • Variance
  • Standard deviation
  • Risk premium
  • Sharpe ratio
  • Excess returns
  • Frequency distribution of annual returns

Bond Pricing, Yields, and Duration

This content covers bond characteristics, pricing, and the inverse relationship between prices and yields, including interest rate risk and duration as a measure of effective maturity.

  • Bond characteristics
  • Par value
  • Coupon rate
  • Bond indenture
  • Bond pricing
  • Present value
  • Annuity factor
  • Inverse relationship between price and yield
  • Yield to maturity
  • Current yield
  • Premium bonds
  • Par bonds
  • Discount bonds
  • Holding period return
  • Zero-coupon bond
  • Bond pricing relationships
  • Interest rate risk
  • Price sensitivity
  • Duration
  • Modified duration

Bond Duration and Interest Rate Sensitivity

This content examines bond duration, interest rate sensitivity, and the duration of a portfolio of bonds.

  • Duration of zero-coupon bonds
  • Duration of coupon bonds
  • Interest rate sensitivity
  • Yield to maturity
  • Modified duration
  • Duration of a level perpetuity
  • Portfolio modified duration
  • Bond maturity

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