Bond Risks and Duration Management
Bond Risks
Interest Rate Risk
Interest rate risk (price risk) is the change in the market prices of bonds due to varying interest rates.
- Bond prices and interest rates are inversely related.
Reinvestment Rate Risk
Reinvestment rate risk refers to the uncertainty surrounding the rate at which interim cash flows (e.g., coupon proceeds) can be invested.
- The higher the coupon or holding period, the higher the reinvestment rate risk.
- If interest rates go down, your interest on reinvested interest will decline.
Heteroskedasticity in Linear Regression Models
LM-Stat (for testing join significance of independent variables)
Heteroskedasticity
Other large sample tests: The Lagrange Multiplier Statistics to test join significance of independent variables
Consider the model:
Explain the procedure of LM-test to test the null hypothesis that 
and 
have no effect on 
once the other factors have been controlled for.
The null hypothesis: 
.
Estimate the restricted model: 
. Get the residuals 
.
Regress
on 
. Get the 
.
Compute 
. Reject the null if 
Understanding Investment Returns, Margin, and Portfolio Optimization
Question 2
Consider the three stocks in the following table. Pt represents the price in time t, and Qt represents shares outstanding at time t. Stock C splits two for one in the last period.
P0 | Q0 | P1 | Q1 | P2 | Q2 | |
A | 120 | 400 | 135 | 400 | 135 | 400 |
B | 60 | 800 | 52.5 | 800 | 52.5 | 800 |
C | 135 | 800 | 150 | 800 | 75 | 1600 |
a. Calculate the rate of return on a price-weighted index of the three stocks for the first period (t = 0 to t = 1).
b. What must happen to the divisor for the price-weighted index in year 2?
c. Calculate the rate of return for the second period
Read MorePortfolio Management and Investment Analysis
Question 2
Consider the three stocks in the following table. Pt represents the price in time t, and Qt represents shares outstanding at time t. Stock C splits two for one in the last period.
P0 | Q0 | P1 | Q1 | P2 | Q2 | |
A | 120 | 400 | 135 | 400 | 135 | 400 |
B | 60 | 800 | 52.5 | 800 | 52.5 | 800 |
C | 135 | 800 | 150 | 800 | 75 | 1600 |
a. Calculate the rate of return on a price-weighted index of the three stocks for the first period (t = 0 to t = 1).
b. What must happen to the divisor for the price-weighted index in year 2?
c. Calculate the rate of return for the second period
Read MoreUnderstanding Cointegration and Error Correction Models in Eviews
In-Class Exercise 7
Question 1
This question helps to familiarize you with the analysis of cointegration and the error correction model. The dataset we are using is forex.csv, which can be downloaded from Moodle.
Part 1: Using Eviews for Analysis
First, load the file into Eviews. To get a sense of the data over the sampling period, highlight and open the two series spotrate and forwardrate. Then choose View > Graph and click OK.
%IMAGE_1%
Clearly, the two series show some trending behavior, and they
Read MoreAnalysis of Cointegration and Error Correction Models
In-Class Exercise 7
Question 1
This question helps to familiarize with the analysis of cointegration and error correction models. The dataset we are using is forex.csv, which can be downloaded from Moodle.
Part 1: Using Eviews for Analysis
First, load the file into Eviews. To get a sense of the data over the sampling period, highlight and open the two series spotrate and forwardrate. Then choose View -> Graph and click OK.
%IMAGE_1%
Clearly, the two series show some trending behavior, and they seldom
Read More