IA Week 9

What determines a bond’s price conceptually?

The present value of its future cash flows

How do bond prices move relative to interest rates?

Bond prices move inversely with interest rates

What does yield to maturity represent?

The total return if the bond is held to maturity

When is a bond priced at par?

When yield to maturity equals the coupon rate

When is a bond priced at a discount?

When yield to maturity is greater than the coupon rate

When is a bond priced at a premium?

When yield to maturity is less than the coupon rate

Why do long-term bonds have higher interest rate risk?

Cash flows are received farther in the future

What is the yield curve?

A graph of yields across maturities

What does an inverted yield curve often signal?

Economic slowdown or recession expectations

What is reinvestment risk?

The risk that coupons are reinvested at lower rates

What does the Efficient Market Hypothesis claim about prices?

Prices reflect available information

What does EMH imply about active management?

It is difficult to consistently outperform the market

What causes trading in financial markets?

Disagreement on value with agreement on price

What is a financial bubble?

Prices deviate significantly from fundamental value

Why don’t rational investors immediately eliminate bubbles?

Because betting against mispricing is risky and hard to time, so arbitrage does not fully correct prices.

What usually causes a bubble to burst?

A sudden loss of confidence or liquidity that forces investors to sell.

What is overconfidence bias?

Overestimating one’s skill or information

What is confirmation bias?

Looking for information that agrees with what you already believe and ignoring information that does not.

What is framing bias?

Making different decisions based on how the same information is presented.

What is prospect theory?

People feel losses more strongly than they feel gains of the same size, so they take different risks to avoid losses.