Equal amounts are invested in bonds with staggered maturities.
The bond ladder works.
If you want to confine your investing to fixed-income securities with maturities of 10 years or less, you can.
You could set up a ladder by investing equal amounts in different issues.
The money from the 3-year issue would be put into a new 10-year note when it matures.
This rolling-over process would allow you to hold a full ladder of 10-year notes.
By rolling into new 10-year issues every 2 or 3 years, the interest income on your portfolio will be an average of the rates available over time.
The lad dered approach is an easy way to invest for a long time.
A key ingredient of this or any other passive strategy is the use of high quality investments that have attractive features.
When investors expect interest rates to decline and when they anticipate an increase in interest rates, they seek attractive capital gains.
This strategy is risky because it relies on an unreliable forecast of future interest rates.
The idea is to increase the return on a bond portfolio by making strategic moves in anticipation of interest rate changes.
Most of the trading is done with investment-grade securities because they are the most sensitive to interest rate movements, and that sensitivity is what active traders hope to profit from.
The concept of duration is brought together with interest rate forecasts.
Aggressive bond investors seek to lengthen the duration of their bonds because bonds with longer durations rise more in price than bonds with shorter durations.
When interest rates fall, investors look for low-coupon and/or moderately dis counted bonds because these bonds have higher durations, and their prices will rise more.
Bond traders try to earn as much money as possible in a short period of time.
When rates start to level off and move up, these investors begin to shift their money out of long, discounted bonds and into high-yielding issues with short maturities.
They do a complete reversal and look for bonds with shorter durations.
When bond prices are dropping, investors take steps to protect their money from capital losses because they are more concerned about preservation of capital.
They usually use Treasury bills, money funds, short-term (two- to five-year) notes and variable-rate notes.
To increase current yield or yield to matu rity, to take advantage of shifts in interest rates, to improve the quality of a portfolio, or for tax purposes, swaps can be executed.
They go by a variety of colorful names, such as "profit takeout," "substitution swap," and "tax swap," but they are all used for one thing: port folio improvement.
The yield pickup swap and the tax swap are both fairly simple and hold a lot of appeal.
If you sold 20-year, A-rated, 6.5% bonds and replaced them with an equal amount of 20-year, A-rated, 7% bonds that were priced to yield 8.5%, you would be doing a yield pickup swap.
The swap would increase your yield to maturity from 8% to 8.5% and increase your interest income from $65 a year to $70 a year.
The yield spreads between different types of bonds make swap opportunities possible.
You can execute swaps by watching swap candidates and asking your broker to do so.
Transaction costs don't eat up all the profits, that's the only thing you need to be careful of.
If you have a large tax liability as a result of selling security holdings at a profit, you can use this technique.
To eliminate or substantially reduce the tax liability associated with capital gains is the objective of the swap.
This is done by selling an issue that has undergone a capital loss and replacing it with a similar obligation.
If you had $10,000 worth of corporate bonds that you sold for $15,000, you would have a capital gain of $5,000.
If you sell securities that have capital losses of $5,000, you can eliminate the tax liability associated with the capital gain.
Let's assume that you have a 20-year, 4% municipal bond that has lost $5,000 in value.
You have a tax shield in your portfolio.
You need to find a swap candidate.
You can find a similar 20-year, 5% municipal issue currently trading at the same price as the issue being sold.
The capital gains tax liability will be eliminated if you sell the 4.75s and buy the 5s at the same time.
You cannot use the same issues in swap transactions.
The IRS would consider that a wash sale.
The capital loss must occur in the same year as the capital gain.
Tax loss sales and tax swaps increase as knowledgeable investors rush to establish capital losses at the end of the year.
Explain how and why an investor would use a bond ladder.
After reading this chapter, you should know what PArt FoUr I InvEstInG is.
The bond market is dependent on the behavior of interest rates.
The amount of current income and capital gains an investor will receive is determined by this.
The total returns obtained from bonds can be affected by market interest rates.
The yield it should provide is the beginning of the process of pricing a Video Learning Aid for bond.
A standard, present value-based model is used to find the dollar price of a bond once Problems P11.1 and P11.2 are known.
Aggressive bond traders use the expected return as a valuation measure to show the total return that can be earned from trading in and out of bonds.
Bond duration takes into account the effects of both reinvestment and price.
The measure captures the extent to which the price of a bond will change depending on the interest rate environment.
It is important that duration is used to immunize whole bond portfolios from changing market interest rates.
The following strategies are used by investors: passive strategies such as buy-and-hold, bond ladders, and portfolio immunization; bond trading based on forecasted interest rate behavior; and bond swaps.
MyFinanceLab will give you further practice, as well as videos, animations, and guided solutions.
The term structure of interest rates has a number of theories.
Discuss the shape of your yield curve.
If there are any of the following events, explain what will happen to the bond's duration measure.
The yield to maturity on the bond has fallen.
The bond is one year closer to maturity.
The market interest rates went from 8% to 9%.
The modified duration is half a year.
An investor comes to you looking for advice.
She wants to put all her money into bonds.
Pick any four bonds, consisting of two Treasury bonds and two corporate bonds, using the resources at your campus or public library.
Determine the current yield and the promised yield.
Find the duration and modified duration for each bond.
If you put an equal amount of money into each of the bonds, you can find the duration for this four-bond portfolio.
If you have $100,000 worth of local currency to invest, use at least three of these bonds to develop a bond portfolio that emphasizes either the potential for capital gains or the preservation of capital.
Explain your logic.
There is a $1,000 par value bond with a 6.5% coupon rate that will mature in 12 years.
Two bonds have a par value of $1,000.
The 15-year bond has a yield of 8%.
The 20-year bond has a yield of 6%.
The prices of the bonds can be found using semiannual compounding.
Annual compounding can be used to repeat the problem.
Discuss the differences in the prices of the bonds.
You have the chance to purchase a bond that has an annual coupon rate of 9%.
A $1,000 par value bond has a current price of $950 and will mature in three years.
A $1,000 par value bond with a 7.25% coupon rate matures in seven years and is currently selling for $987.
An investor is considering purchasing an 8%, 18-year corporate bond that's being priced to yield 10%.
She believes that the bond will be priced in the market to yield 9%.
Find the price of the bond in one year using annual compounding.
If the investor's expectations are met, you can find the holding period return on this investment.
The WSJ has a story about a bond that is currently selling in the market for $1,070 with a coupon of 11% and a 20-year maturity.
The promised yield is calculated using annual compounding.
A bond is selling for $928.62.
The coupon is 10% and the maturity is 10 years.
The yield to maturity is calculated using annual compounding.
The current yield on the 10-year bond is 8%.
The yield on this bond can be found using annual compounding.
This time use semiannual compounding to find yield to maturity, instead of repeating the promised yield calculation.
You are looking at an outstanding issue of $1,000 par value bonds with an 8.75% coupon rate that matures in 25 years and make quarterly interest payments.
A person works for a broker.
One of his clients is offered a bond.
The bond has a par value of $1,000 and a call price of $1,100.
Semiannually coupon payments are made.
The price of the bond should decline to $875.
Bond A is a 20-year, 9% bond that is priced to yield 10.5% and is being looked at by an investor.
Bond B is a 20-year bond with an annual pay of 8%.
Both bonds have call prices of $1,050.
A zero-coupon bond that matures in 20 years is currently selling for $509 per $1,000 par value.
A zero-coupon bond that matures in eight years has a yield of 7%.
A 20-year bond was quoted at 10% of par.
If the bond has a par value of $1,000, you can find the current yield and promised yield.
If it were priced to yield 10%, how much an investor would have to pay for this bond would be determined using semiannual compounding.
An 8% coupon on a long-term bond is what an investor would pay.
He wants to sell the issue for $950 in three years.
Find the yield to maturity for each of the bonds using annual compounding.
The yield to call for each bond can be found using annual compounding.
The Macaulay duration is equal to 8.3 and the yield is 6.2%.
The Macaulay duration of the bond is 8.42 and it is priced to yield 7%.
An investor wants to find the duration of a noncallable bond that's currently priced in the market and yields 7%.
The effective duration of this bond can be found using a 50 basis point change in yield.
An aggressive bond trader, who likes to speculate on interest rate swings, is named Stacy Picone.
She expects market interest rates to fall to 7% within a year.
A 25-year, zero-coupon bond or a 20-year, 7.5% bond are the two options that are being considered by Stacy.
A 35-year-old bank executive has just been given a large sum of money.
He decided to apply the concept of duration to his bond portfolio after several years in the bank's investments department.
If you put $250,000 into each of the four U.S. Treasury bonds, you can find the duration of the whole bond portfolio.
Dave and Marlene have always had a large portion of their investments in fixed-income securities.
They go after both attractive current income and capital gains and are fairly aggressive in their investment posture.
It is now 2016 and Marlene is evaluating two investment decisions: one involves an addition to their portfolio, the other a revision to it.
A short-term trading opportunity is the Carters' first investment decision.
In order to buy a 7.5%, 25-year bond that is currently priced at $852 to yield 9%, she feels that in two years the promised yield of the issue should drop to 8%.
A bond swap is the second.
The bonds that the Carters hold are priced at $775.
They want to improve both current income and yield to maturity and are considering one of three issues as a possible swap candidate.
All of the swap candidates have the same issue characteristics.
The current yield and promised yield are for the bond the Carters currently hold and each of the swap candidates.
Grace Hesketh is the owner of an extremely successful dress boutique in downtown Chicago.
Grace's first love is high fashion, but she's also interested in investing in bonds and other fixed-income securities.
A substantial portfolio of securities has been built up by PArt FoUr I InvEstInG.
She knows how to apply the latest investment techniques to her own investments.
Grace is playing with the idea of immunizing a large portion of her bond port folio.
She wants to use the proceeds from this part of her portfolio to buy a vacation home in her home state of Oregon.
She plans to use the $200,000 she has invested in the corporate bonds to help her achieve this.
Find the current yield and promised yield for each bond in the portfolio.
If interest rates were to rise by 75 basis points, the Macaulay and modified durations of each bond in the portfolio should be calculated.
Put together a $200,000 portfolio for Grace using one or more of the bonds.
All bonds are priced according to the value of their future cash flow streams.
Market yield is what drives bond prices.
In the market for bonds, the appropriate yield at which the bond should sell is determined first, and then that yield is used to find the market value of the bond.
The required rate of return is also referred to as the market yield.
This is the rate of return that a rational investor requires before he or she will invest in a fixed-income security.
To answer the bond valuation questions, create a spreadsheet and model it.
H&W Corporation has a bond issue with an annual-pay coupon of 5.625% and a par value of $1,000.
The bond has a maturity of 23 years.
The rate of return on securities of similar-risk grade is required.
Determine how the price of the issue reacts to changes in the bond's yield.
The value of the security can be found by looking at the Ytm.
It is a premium, par, or discount bond to label your findings.
The Jay & Austin Company has a bond issue with a par of $1,000, a semiannual pay coupon of 6.5%, and a remaining maturity of 22 years.
Bond prices and yields, interest rates and risks, bond price volatility, and bond redemption provisions are some of the topics covered in Chapters 10 and 11 of this text.
Reducing credit risk is most likely to be done by sinking funds.
An analyst stated that a callable bond has more price appreciation potential than a noncallable bond.
The analyst's statement is most likely incorrect.
Treasury StrIPS are securities created by stripping the coupon and principal pay ments from ordinary bonds and selling them as individual securities.
A Treasury note with 4 years to maturity can be broken into many.
Frieda Wannamaker is an investor who is taxed at the 28% income-tax rate.
She is considering purchasing a tax-exempt bond.
The yield on this bond is close to the taxable equivalent.
The present value of a $1,000 par value zero-coupon bond with a three-year maturity is close to a.
A bond with 14 years to maturity and a coupon rate of 6.375% has a yield to maturity of 4.5%.
As the bond approaches maturity, the value will most likely increase.
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