Money devil

Measuring the risk of Bond futures

admin — Mon, 29 Mar 2010 10:05:36 +0000

Most bond futures contracts are based on a hypothetical benchmark bond. The Chicago Board of Trade’s U.S. Treasury bond futures contract is based on a 6 percent bond with at least 15 years from the futures expiration to maturity or the first call date. Even though the benchmark bond has a 6 percent coupon, any bond meeting the maturity requirement can be delivered. At any time, a single bond exists that the holder of the short position would find optimal to deliver if current conditions continued. That bond is called the cheapest to deliver and can be thought of as the bond on which the futures contract is based. In other words, the cheapest to deliver bond is the underlying. The responsiveness of the futures contract to an interest rate change is equivalent to the responsiveness of that bond on the futures expiration day to an interest rate change.
We can think of this concept as the responsiveness of the underlying bond in a forward context. This responsiveness can be measured as that bond’s modified duration on the futures expiration and, as such, we can use the price sensitivity formula to capture the sensitivity of the futures contract to a yield change. Accordingly, we shall, somewhat loosely, refer to this as the implied duration of the futures contract, keeping in mind that what we mean is the duration of the underlying bond calculated as of the futures expiration. Moreover, we also mean that the underlying bond has been identified as the cheapest bond to deliver and that if another bond takes its place, the duration of that bond must be used. We use the term implied to emphasize that a futures contract does not itself have a duration but that its duration is implied by the underlying bond. In addition to the duration, we also require an implied yield on the futures, which reflects the yield on the underlying bond implied by pricing it as though it were delivered at the futures contract expiration.
Hence, we can express the sensitivity of the futures price to a yield change as
where MDURf is the implied modified duration of the futures, f is the futures price, and Ayf is the basis point change in the implied yield on the futures.
Now that we have a measure of the responsiveness of a bond portfolio and the responsiveness of a bond futures contract to interest rate changes, we should be able to find a way to balance the two to offset the risk.

voluntary exchange

admin — Wed, 22 Jul 2009 13:39:15 +0000

When individuals engage in a voluntary exchange, both parties are made better off. In the above example, Janet has the option of accepting or declining Brad’s offer of a trade. If she accepts his offer, she does so voluntarily. Janet would agree to this exchange only if she expects to be better off as a result. Because she likes tomatoes better than onions, Janet’s enjoyment of her salad will be greater with this trade than without it. On the other side, Brad has voluntarily made this offer of an exchange to Janet because Brad believes he will also be better off as a result of the exchange.
People tend to think of making, building, and creating things as productive activities.
Agriculture and manufacturing are like this. They create something genuinely new, something that was not there before. On the other hand, trade-the mere exchange of one thing for another4oes not create new material items. You might be tempted to think that if goods are merely being traded, one party will be better off and the other worse off. A closer look at the motivation for trade helps us see through this popular fallacy. Exchange takes place because both parties expect it will make them better off. If they didn’t, they wouldn’t agree to do it. For example, if Janet liked onions better than tomatoes, she wouldn’t have traded with Brad. The fact that she agreed to the trade means she thinks she has something to gain by doing so. Brad thinks the same thing when it comes to his tomatoes. In other words, because their exchange is voluntary, both Janet and Brad are made better off.

Trade creates value

admin — Wed, 22 Jul 2009 13:38:08 +0000

Why do individuals trade with each other, and what is the significance of this exchange? We have learned that value is subjective. It is wrong to assume that a particular good or service has a fixed objective value just because it exist^.^ The value of goods and services generally depends on who uses them, and on circumstances, such as when and where they are used, as well as on the physical characteristics. Some people love onions, whereas others dislike them exceedingly. Thus, when we speak of the “value of an onion,” this makes sense only within the context of its value to a specific person. Similarly, to most people an umbrella is more valuable on a rainy day than on a sunny one.
Consider the case of Janet, who loves tomatoes but hates onions, and Brad, who loves onions but hates tomatoes. They go out to dinner together and the waiter brings their salads. Brad turns to Janet and says, “I’ll trade you the tomatoes on my salad for the onions on yours.” Janet gladly agrees to the exchange. This simple example will help us illustrate two important aspects of voluntary exchange.

Opportunity cost and the real world

admin — Wed, 22 Jul 2009 13:36:35 +0000

Is real-world decision making influenced by opportunity costs? Consider your own decision to attend college. Your opportunity cost of going to college is the value of the next best alternative, which could be measured as the salary you would earn if you had chosen to go directly into full-time work instead. Every year you stay in college, you give up what you could have earned by working that year. Typically, students incur opportunity costs of $80,000 or more in forgone income during their stay in college.

But what if the opportunity cost of attending college changes? How will it affect your decision? Suppose, for example, that you received a job offer today for $250,000 per year as an athlete or an entertainer, but the job would require so much travel that school would be impossible. Would this change in the opportunity cost of going to college affect your choice as to whether to continue in school? It likely would. Going to college would mean you would have to say goodbye to the huge salary you’ve been offered. You can clearly tell from this example that the monetary cost of college (tuition, books, and so forth) isn’t the only factor influencing your decision. Your opportunity cost plays a part, too.

Even when their parents pay all the monetary expenses of their college education, some students are surprised to learn that they are actually incurring more of the total cost of going to college than their parents. For example, the average monetary cost (tuition, room and board, books, and so forth) for a student attending college is about $10,000 per year (S40,OOO over four years). Even if the student’s next best alternative were working at a job that paid only $15,000 per year, over four years, that would amount to $60,000 in forgone earnings, So, the total cost of the student’s education would be $100,000 ($40,000 in monetary costs paid by the parents and $60,000 in opportunity costs incurred by the student).

Now consider another decision made by college students-whether to attend a particular class meeting. The monetary cost of attending class (bus fare, parking, gasoline costs, and so on) remains fairly constant from day to day. Why then do students choose to attend class on some days and not on others? Even though the monetary cost of attending class is fairly constant, a student’s opportunity cost can change dramatically from day to day.

Some days the next best alternative to attending class may be sleeping in or watching TV. Other days, the opportunity cost may be substantially larger, perhaps the value of attending a big football game, getting an early start on spring break, or having additional study time for a crucial exam in another class. As options like these increase the cost of attending class, more students will decide not to attend.

Failure to consider opportunity cost often leads to unwise decision making. Suppose that your community builds a beautiful new civic center. The mayor, speaking at the dedication ceremony, tells the world that the center will improve the quality of life in your community. People who understand the concept of opportunity cost may question this view. If the center had not been built, the resources might have funded construction of a new hospital, improvements to the educational system, or housing for low-income families. Will the civic center contribute more to the well-being of the people in your community than these other facilities? If so, it was a wise investment. If not, your community will be worse off than it would have been if decision makers had chosen a higher valued project.

Enroll at university of phoenix new orleans and give yourself a lot of opportunities.

Opportunity cost

admin — Wed, 22 Jul 2009 13:35:08 +0000

An unpleasant fact of economics is that the choice to do one thing is, at the same time, a choice not to do something else. Your choice to spend time reading this blog is a choice not to spend the time playing video games, listening to a math lecture, or going to a party. These things must be given up because you decided to read this lob instead. As we indicated in earlier posts, the highest valued alternative sacrificed in order to choose an option is called the opportunity cost of that choice. In economics when we refer to the “cost” of an action, we are referring to its opportunity cost.
Opportunity costs are subjective because they depend upon how the decision maker values his or her options. They are also based on the expectations of the decision maker- what he or she expects the value of the forgone alternatives will be. Because of this, opportunity cost can never be directly measured by someone other than the decision maker. Only the person choosing can know the value of what is given up. This makes it difficult for someone other than the decision maker-including experts and elected officials-to make choices on that person’s behalf. Moreover, not only do people differ in the trade-offs they prefer to make, but their preferences also change with time and circumstances. Thus, the decision maker is the only person who can properly evaluate the options and decide which is the best, given his or her preferences and current circumstances.
Monetary costs can be measured objectively in terms of dollars and cents (or yen, lira, and so forth). They also represent an opportunity cost. If you spend $20 on a new CD, you must now forgo the other items you could have purchased with the $20-a new shirt, for example. However, it is important to recognize that monetary costs do not represent the total opportunity cost of an option. The total cost of attending a football game, for example, is the highest valued opportunity lost as a result of both the time you spend at the game and the amount of money you pay for your ticket. In cases like the purchase of a CD, where there is minimal outlay of time, effort, and other resources to make the purchase, the monetary cost will approximate the total cost. Contrast this with a decision to sit on your sofa and listen to your new CD, which involves little or no monetary cost, but has a clear opportunity cost of your time. In this second case, the monetary cost is a poor measure of the total cost.

Employer-guaranteed sale

admin — Sat, 07 Mar 2009 11:52:14 +0000

As an additional incentive for a proposed transfer or relocation, some companies and employers may guarantee the sale of the employee’s current home. Often, the employer will simply guarantee to purchase the property, and resell it later.
If an employer has guaranteed to purchase the applicant’s current residence as part of a transfer or relocation, the existing mortgage loan on that residence is not treated as long-term liability. The applicant can obtain a new mortgage loan without having to bother with the sale of his or her current home.
As usual, however, there are always conditions:
1. The employer’s responsibility to purchase the property is clearly defined and documented.
2. The borrower’s financial responsibility for the property is clearly short-term.
3. It is readily apparent that the employer has the financial capacity to honor the guarantee.

Collections, delinquencies and judgments

admin — Sat, 07 Mar 2009 11:51:25 +0000

Collections and judgments are serious liabilities that must be addressed as quickly as possible, if the applicant is pursuing mortgage finanicng. However, not all collection accounts and judgments are the same.
Judgments are probably the most serious of the negative credit entries. Bankruptcies and foreclosures are the most damaging types of judgments. Judgments remain on the applicant’s credit report for ten (10) years after the discharge date. Other judgments include personal judgments and tax liens.
Delinquencies are past due bills that are at least 30 days late. Strictly speaking, delinquencies refer to past due amounts on currently open accounts. If the delinquencies are allowed to fester, they become a collection or charge-off account. In the case of cars, they can result in repossession.
Medical and utility collections are some of the most common type of collections seen on credit reports. Medical collections usually are now counted as seriously against the applicant. Most mortage lenders will require the borrower to pay off the collection and delinquency amounts prior to or duing the closing.

Interim financing

admin — Sat, 07 Mar 2009 11:50:24 +0000

Short-term financing in anticipation of a long-term loan is often called interim financing. Many construction loans are actually interim loans. Construction loans are typically short-term financing that is paid off as soon as the building is completed.
Another form of interim financing may involve obtaining a second mortgage on the applicant’s current home in order to cash out sufficient funds for the down payment on another purchase. These interim financing arrangements are normally not counted against the applicant. However, they must be paid off prior to or during the closing.

Debts on other real estate

admin — Sat, 07 Mar 2009 11:49:24 +0000

Mortgage loans on investment (non-owner-occupied) properties are treated differently from other installment loans. The payments on such mortgage loans are not directly held against the applicant. Instead, these investment property loan payments are held primarily against the property.
Ideally, the rental income from investment properties should offset the monthly payment requirements for those properties. In fact, most investment properties should provide the owner with an operating profit, and 75% of this net profit is actually credited to the applicant as additional income.
However, if the property is operating with a net loss, that shortfall is counted against the applicant as long-term debt.

Alimony, child support & separate maintenance

admin — Sat, 07 Mar 2009 11:48:31 +0000

These liabilities are considered long-term debts if they will continue for at least ten more months. Separate maintenance is a form of support payments for couples who are involved in a formal separation, but not yet divorced.
If an applicant is divorced or separated, he or she must submit to the mortgage lender a copy of the separation agreement or divorce decree, with accompanying property settlement agreement. These documents will indicate the monthly alimony, child support and separate maintenance payments that is expected from the applicant.