investment analysis midterm #3 shatz rutgers

What significant event occurred around the Strait of Hormuz and the Persian Gulf on March 11-12, 2026?

Three ships were destroyed, escalating the conflict between the US/Israel and Iran.

What was the CPI reported at during the current event?

The CPI was steady at 2.4%.

What is a key benefit of Municipal (Muni) Bonds?

Interest income from Muni Bonds is exempt from federal income taxation.

What are General Obligation Bonds backed by?

They are backed by the full faith and credit of the issuer, essentially the taxing power of the state.

What distinguishes Revenue Bonds from General Obligation Bonds?

Revenue Bonds are backed by specific projects and are considered more risky.

What is an Industrial Development Bond?

A bond issued to finance commercial enterprises, allowing private firms to borrow at tax-exempt rates.

What are Tax Anticipation Notes?

Short-term muni debt issued to raise money before taxes are collected.

What is the Equivalent Taxable Yield (ETY)?

The rate a taxable bond must offer to match the after-tax yield on a tax-exempt muni.

How do you calculate the Equivalent Taxable Yield?

r_equiv_taxable = r_muni / (1 - t).

What is the Cutoff Tax Bracket (CTB)?

The tax bracket where investors are indifferent between a taxable and tax-exempt bond.

What is the price/yield relationship for bonds?

There is an inverse relationship; as interest rates rise, bond prices fall, and vice versa.

What does Yield to Maturity (YTM) represent?

The internal rate of return that makes the present value of cash flows equal to the bond's price.

What is Macaulay Duration?

The average weighted time until cash flow payments are received.

How is Macaulay Duration calculated for a zero-coupon bond?

It is equal to the maturity of the bond.

What is the formula for Macaulay Duration?

D = { (summation from t=1 to m of t*C_t/(1-r)^t) / (summation of C_t/(1-r)^t) }.

What happens to the present value of future cash flows as interest rates increase?

The present value decreases.

What is the significance of the present value in bond pricing?

It represents the value today of future cash flows from the bond.

What is the Current Yield formula?

Current Yield = Coupon / Price.

What is the effect of increasing the denominator in the YTM calculation?

It can lead to a lower yield if the cash flows remain constant.

What is the relationship between coupon payments and their present value?

Earlier coupon payments are worth more than later ones due to the time value of money.

What is a key consideration when comparing taxable and tax-exempt bonds?

After-tax returns should be compared to determine the better investment.

What does a higher tax bracket imply for the value of tax-exempt munis?

Tax-exempt munis become more valuable to investors in higher tax brackets.

What is the purpose of comparing after-tax returns?

To help choose between taxable and tax-exempt bonds.

What does the term 'present value of cash flows' refer to in bond math?

It refers to the current worth of future cash flows discounted at the appropriate interest rate.

What is the primary risk associated with Revenue Bonds?

They can default if the specific project does not generate expected revenue.

What is the typical maturity range for Municipal Bonds?

They can be issued across a wide range of maturities.

What is the impact of a flat yield curve on YTM calculations?

It assumes the same rate for one versus multiple years, complicating average yield measures.

What does the fulcrum represent in the context of bond duration?

The fulcrum represents duration.

How does changing the maturity of a bond affect its duration?

Shorter maturity leads to shorter duration; increased maturity leads to increased duration.

What happens to bond duration when yields drop to zero?

All cash flow containers would be filled with water, indicating longer durations.

What is the effect on duration when yields increase significantly?

Higher yields result in shorter durations.

How does the coupon frequency affect bond duration?

More frequent coupons shorten duration; less frequent coupons lengthen duration.

What is modified duration?

Modified duration measures the percentage change in the full price of a bond given a 100 basis point change in yield.

What is the formula for calculating Basis Point Value (BPV)?

BPV = modified duration / 100 * full price.

What is the relationship between bond prices and yields?

Bond prices are sensitive to yields, exhibiting an inverse relationship.

Which bond would have greater sensitivity to interest rate changes: a longer maturity bond or a shorter maturity bond?

A longer maturity bond would have greater sensitivity.

Which bond would have greater sensitivity to interest rate changes: a higher coupon bond or a lower coupon bond?

A lower coupon bond would have greater sensitivity.

What type of bond would maximize profits if yields are expected to decline?

A 30-year zero coupon bond would maximize profits due to its longer duration.

What does a higher modified duration indicate about a bond?

It indicates a longer time to maturity, lower coupon, and lower yield.

How is accrued interest calculated?

Accrued interest is calculated based on the time elapsed since the last coupon payment relative to the total days in the coupon period.

What is the flat price of a bond?

The flat price is the price of the bond excluding accrued interest.

What is the full price of a bond?

The full price is the flat price plus accrued interest.

How do you calculate modified duration from BPV?

Modified duration = (BPV * 100) / full price.

What is the significance of the last coupon payment date in bond calculations?

It is used to determine the days from the previous coupon to the settlement date for calculating accrued interest.

What is the impact of inflation on bond yields?

If inflation is too high, yields go up and prices go down.

What is a basic hedge ratio in bond trading?

The basic hedge ratio is calculated as HR = BPVt / BPVh, where t is the security being hedged and h is the hedging vehicle.

Why is hedging by modified duration alone incorrect?

Because two bonds may have similar durations but substantially different prices.

What is the effect of a lower coupon on bond duration?

A lower coupon results in a longer duration.

What happens to the fulcrum when yields decrease?

The fulcrum must move to the left, indicating longer durations.

What is the relationship between duration and cash flow payments?

Longer cash flow payments lead to longer durations.

What is the effect of a zero-coupon bond on duration?

A zero-coupon bond has the longest duration since it only pays at maturity.

How does the price of a bond change with a 1 basis point change in yield?

The price changes by the amount calculated using BPV.

What is the basic hedge ratio formula?

HR = BPVt / BPVh, where t is the security being hedged and h is the hedging vehicle.

Why is BPV important in hedging?

BPV represents the overall profit/loss in dollars that one is trying to offset with the hedge.

What does modified duration alone fail to account for in hedging?

It does not consider the differences in prices between securities with similar durations.

What is the Yield Beta Adjusted BPV Hedge formula?

HR = (BPVt / BPVh) * B, where B = change in Yt / change in Yh.

What does the yield beta represent?

The expected change in the yield of the security being hedged relative to the hedging vehicle.

How does convexity relate to duration?

Convexity is the second derivative of price concerning yield, indicating how duration changes as yields change.

What happens to prices as yields decrease?

Prices increase at an increasing rate due to rising duration.

What is the effect of convexity on price changes for large moves in yield?

Prices will fall by less than BPV predicts when yields rise and rise by more than BPV predicts when yields fall.

What is the basic formula for computing percentage price change?

%change in P = -mod dur(change in Y) + (½)Convexity(change in Y^2).

What is positive convexity?

It benefits the investor who is long the security, as prices increase at an increasing rate when yields decrease.

How do investors prefer securities with higher convexity?

Investments with greater convexity typically have lower yields.

What is an example of negative convexity?

Mortgages, due to pre-payment risk.

What does the term 'BPV' stand for?

Basis Point Value, which measures the change in the price of a bond for a 1 basis point change in yield.

What is the significance of the hedge ratio in risk management?

It determines the amount of the hedging vehicle needed to offset the risk of the position being hedged.

What does a yield beta of 2.0 indicate?

For every 1 basis point change in the yield of the security being hedged, the yield of the hedging vehicle changes by 2 basis points.

What does the term 'convexity' describe in bond pricing?

The curvature of the price-yield relationship, indicating how price changes with yield changes.

What is the impact of increasing coupons on convexity?

Increasing coupons generally decrease convexity.

What is the relationship between maturity and convexity?

As maturity increases, convexity also increases.

What does it mean if a bond's price is a nonlinear convex inverse function of its yield?

The bond's price does not change linearly with changes in yield; it exhibits convexity.

What is the role of historical relationships in yield beta adjustments?

They help determine how different securities will perform relative to each other in future yield changes.

What is the significance of the example involving a casino coin flip game?

It illustrates how demand can affect pricing and perceived value, similar to how convexity affects bond pricing.

How does a bond with high convexity behave in a market with falling yields?

It tends to increase in price at an increasing rate.

What is the relationship between BPV and yield changes?

BPV changes when yields rise or fall, affecting the accuracy of price predictions.

What does a hedge ratio of 8 indicate in the context of bond A and bond B?

You would need to short $800 face value of bond B to hedge a long position in bond A.

What is the implication of a hedge fund manager's decision based on BPV?

Without knowing the size of the position, BPV alone cannot determine the risk or justify a layoff.

What are municipal bonds?

Debt securities issued by state and local governments to raise money.

What is a key tax advantage of municipal bonds?

Interest income is exempt from federal income tax and usually from state and local taxes for residents of the issuing state.

Why do municipal bonds have lower yields compared to taxable bonds?

Investors accept lower yields because the interest is tax-exempt.

What are General Obligation (GO) bonds?

Bonds backed by the full faith and credit of the issuing government, which can raise taxes to pay them off.

What are Revenue bonds?

Bonds issued to finance specific projects, backed only by the revenues from those projects.

What are Industrial Development Bonds (IDBs)?

A type of revenue bond issued to finance commercial/private enterprises, where the private company is responsible for repayment.

What are Tax Anticipation Notes (TANs)?

Short-term municipal debt issued to cover expenses before tax revenues come in.

What is the purpose of long-term municipal debt?

To fund large capital investments such as infrastructure, schools, and public works.

What is the formula for after-tax return comparison between taxable and municipal bonds?

After-tax return on taxable bond = r(taxable) x (1 - t).

What does the equivalent taxable yield formula indicate?

r(equivalent taxable) = r(muni) / (1 - t), showing the yield a taxable bond must offer to match a muni's after-tax return.

What is the cutoff tax bracket?

Cutoff Tax Bracket = 1 - (r(muni) / r(taxable)), indicating the tax bracket at which an investor is indifferent between taxable and muni bonds.

What does a higher muni-to-corporate yield ratio indicate?

It means munis are relatively less attractive tax-wise, as the tax benefit built into their price is smaller.

What are the three types of municipal bonds?

General Obligation bonds, Revenue bonds, and Industrial Development Bonds.

What is the main takeaway regarding tax brackets and municipal bonds?

Higher tax brackets make municipal bonds more attractive due to the value of tax exemptions.

What is the significance of the ratio of muni yields to corporate Baa-rated yields?

Historically averages around 0.70, indicating the relative attractiveness of munis compared to corporates.

What is a simplified rule of thumb for municipal bonds?

Always compare equal-risk securities and consider individual tax situations.

What is the primary purpose of municipal bonds?

To raise funds for public projects and services.

What is the relationship between risk and yield in municipal bonds?

Riskier bonds typically offer higher yields to attract investors.

How do high-income investors influence the municipal bond market?

They find munis valuable, driving prices up and yields down.

What is the role of the state in Industrial Development Bonds?

The state lends its ability to issue tax-exempt debt to private companies for projects that benefit the state.

How do TANs function for local governments?

They bridge short-term cash flow gaps before tax revenues are received.

What is the impact of tax-exempt status on municipal bond yields?

It allows municipal bonds to have lower yields while still being attractive to investors.

What should investors consider when choosing between taxable and municipal bonds?

Their own tax situation and the after-tax yield of each option.