REading 2.1

what do sample statistics use

well down data

mean

variance

correlation

what is the cleanest approach to forecasting

sample stats but it can be impreciase

shrinkage estimate

its applied to historical estimate when simple historical results do not fully reflect expectd future conditions

how does a time series work

forecast a variable using lagged values of the same variable w

what does a time series specifically allow for

incorporating dynamatics/ vols into the forecast

plus for usuing DCF for forecastis

they have a correct empahasis on future cash flows of the asseat

and they can back out required return

DCF model uses what as estimate of expected return

YTM

if investment horizon is shorter than mac duration, what is more dominant

capital gain/loss over the reinvestment impact

Mac Duration is calculated from

mod duration * bonds YTM

what is the building block approach

required return =

risk free rate + term prem + credit prem + liquid prem

short term default free rate

the risk free rate- from the most liquid risk free instrument matching the forecast horizon

when is the short term risk free rate bad to use

when investment horizon much longer than that maturity what

what are some alternates to the short term risk free rate

longer term zero coupon yield

expected roll over short term rates

futures implies short term rates

what are 4 primary drivers of term preium

• inflation

• recession hedge properties

• supply and demand

• business cycle effects

explain the dynamci of a demand driven inflation and to recession and term premium wiht bonds

economy hot, inflation hot so central bank needs to raise rates and bonds prefrom well bc their returns are good (high prices, low rates), so the term premium will be low for bonds

explain the dynamic with supply dirven inflation and term premium with bond yields

say oil embargo, higher inflation, lower growth

yields high, bond prices low and the returns are bad

AND the stocks are down

so term premium is high

greater supply of long term bonds relative to demand

long term yield rise

term premium rises

how do business cycles affect term premiums

expansion— higher term premiums

contraction— lower term premiums

what is cochrane and piazesi curve factor

a measure that captures both the slope and curv of yield curvekim

what is kim and wright premiums

a three factor model of the term structure

what is the supply indicator

proportion of debt w a maturity of greater than 10 years

what are examples of cyclical proxies

corporate profit to GDP ratio

business confidence

unemployment rate

is the yield spread a good preditor of future default rates

no… no evidence

what are the 2 main components of a credit spread

expected defualt losses

credit premium

credit premium

compensation investors require for bearing the risk of default (beyond the expected loss itself)

Does the credit premium equal expected default losses?

No.

• Expected default losses compensate for anticipated losses.

• Credit premium compensates for bearing the uncertainty of those losses.

Both together contribute to the credit spread.

why isnt the yield spread a relatible predicotr of future defaults

-because changes in yield spreads mostly reflect

• risk appreite

• market stress

  • investor sentiment

what variables have the strongest predicitve power for credit spreads

• stock returns

• stock vol

  • risk free interest rate

what economic variables are weak predictive power for credit spreads

GDP growth

changes in default rates

an increase in a bonds spread is observed- does that mean that expected default losses increased

no- spread could widen bc credit premium increased

bonds w very high credit quality have credit premium and spreads mainly driven by

downgrade biaswhat

what is downgrade bias

asymmetrical risk indicating that a downgrade is more likely than a credit improvement or upgrade

what type of indicator is steed yield curves and why

indicate high credit and term premiums

bullish indicators— imply larger compensation for credit losses

what does a high corportate bond OAS typically indicate

high credit premium.. investors receiving greater com[ for bearing risk

(OAS is the credit and liquidity charge added for a corp bond over a treasury bond)

at which tenor do credit premiums tend to be higher and why

short maturities

— due to event risk and illiquidity

what is the barbell strategy used to take advatnage of

take credit risk from shorter maturity bonds an take duration risk from longer maturities

when is a bond most liquid

during the earliest stages—- the first few weeks

6 characteristics of liquid bonds

-issues at par or market rates

-new

-large

-well known issuer

-simple in strucutre

-high credit qulaity