Chapter 11:Interest Rate Risk and Sensitivity· All four bonds illustrate bond price decreases when yields rise and that the price curve in convex.- Convex: the price decreases in yields have bigger impacts on price than in yields of equal magnitude.- Convexity is an important relationship between bond prices and bond yieldso Bond prices and yields are inversely relatedo As yields increase bond prices fallo As yields fall, bond prices increase- An increase in a bonds YTM results in a smaller price change than a decrease in yield of equal magnitude.- Prices of long term bonds tend to be more sensitive to interest rate changes than prices of short term bonds.- The sensitivity of a bond prices to changes in yields increases at a decreasing rate as maturity increases.  Interest rate risk is less than proportional to bond maturity.- The sensitivity of a bonds price change in its yield is inversely related to the YTM at which the bond is currently selling.- This general principle was discovered by Malkiel- All other things equal just remember, the bond with the longest duration has the longest bond with the largest coupon.- The shortest duration on the other hand is the shortest bond, ex. 10 year bond with the smallest coupon (zero)- The duration of a perpetuity varies inversely with interest rates- The duration of a 6-year zero coupon bond is six years.· Bond Price Volatility - Price volatility increases at a decreasing rate as maturity of a bond increases.- All else equal, the price volatility will be higher for bonds with lower coupon rates.- Bond prices tend to be more sensitive to changes in yield when the yield islower than the original YTM- Duration has to do with assessing a bonds price volatility. A bonds duration is lower when coupon rate is higher. Macaulay’s Duration- the measure of the effective maturity ofa bond- Duration has 3 main factors Measure of the interest rate sensitivity Immunizing portfolio for interest rate risk Simple summary of the effective average maturity of the portfolios· Immunization- A strategy to shield net worth from interest rate movements.- The target date of an immunization would be good for people who have pension funds.Active Bond Management- Substitution swap: exchange of one bond for a bond with similar attributes but more attractively priced.- Intermarket spread swap: switching from one segment of the bond market to another. Rate Anticipation swap: a switch made in response to forecasts of interest rate changes Pure Yield pickup swap: moving to higher yield bonds usually with longer maturities. Tax swap: swapping similar bonds to receive a tax benefit. Horizon analysis: forecast bond returns based largely on a prediction in the yield curve at the end of an investment horizon.Chapter 13- Book Valueo The net worth of common equality according to a firms balance sheeto Also known as the accounting measureo The liquidation value is the net amount per share  Can be realized by selling the assets of a firm and paying off the debt If the market price drops below the liquidation level, the firm becomes an attractive takeover target.o The replacement cost: the cost to replace the firms assets.- Intrinsic value v. Market Priceo The intrinsic value is the present value of a firms expected future net cash flows discounted by the required rate of return.o Denoted by Voo This includes dividends and the proceeds from the sale of a stock.- Dividend Discount Modelso The intrinsic value is the present value of the dividend to be received at the end of the first year, or D1 and the expected sales price P1.- DDMo A formula for the intrinsic value of a firm equal to the present value of all expected future dividends. o The stock price should equal the PV of all expected future dividends into perpetuity.o The DDM asserts that stock prices are determined ultimately by the cash flows accruing to stockholders. These are called dividends.o Constant growth DDM- a form of the dividend discount model that assumes dividends will grow at a constant rate. Constant growth DDM is only valid when g is less than k. If g is greater than k, the growth rate must be unsustainable in the long run. The constant growth DDm implies that a stocks value will be greater- The larger its expected dividend per share- The lower the market capitalization rate, ko K can have a negative effect- The higher the expected growth rate of dividends. This stock price is expected to grow at the same rate of the dividends.o Dividend payout ratio: percentage of earnings paid out in dividends. If a firm cuts payout ratios you know the retention ratio will increaseo Plowback ratio: fraction of earnings that are reinvested in the firm. A lower reinvestment plan allows the firm to pay higher initial dividends but results in a lower dividend growth rate. A higher reinvestment plan will provide higher dividends.o If the stock price equals its intrinsic value and its growth rate can be sustained then the stock should sell at Po = D1/ k-go Two stage DDM- dividend discount model in which dividend growth is assumed to level off at some future date.Chapter 14- Major financial Statementso Income statement: A financial statement showing a firms revenues and expenses during a specified period.o Balance Sheet: An accounting statement of a firms financial position at a specified time. Shareholders equity is divided into par value stock, capital surplus, and retained earnings.o Statement of Cash Flows: a financial statement showing a firms cash receipts and cash payment during a specified period.Chapter 18- Active V. Passive Managemento Active management: attempts to achieve portfolio returns with more than commensurate risk, whether by forcasting broad markets or by identifying mispriced securities.o The dividing line between active and passive is the forcasting of future rates of return on an asset class or individual assets.o Market timing: a strategy that moves funds between the risky portfolio and cash based on forecasts of relative performance.o Active management has two components: market timing and security analysis.- Sharpe Ratioo The M2 measure is a variant of the sharpe measureo Sharpe is measured by average excess return and standard deviationo The sharpe ratio is the reward to volatility ratioo The sharpe ratio has a clear interpretation, namely the incremental