The Strategic Bond Investor

Here's a book that I believe the notes are more interesting to read than the book. Book is a tedious read so I do not recommend it for most.

Anthony Crescenzi, “The Strategic Bond Investor”, McGraw-Hill, 2002

Author Crescenzi is chief bond market strategist at Miller Tabak & Co., and founder and daily market analyst of Bondtalk.com.

Websites where investors can learn about the bond market:
· Bondmarkets.com
· Investinginbonds.com
· Publicdebt.treas.gov
· Moodys.com
· Standardandpoors.com
Others: Bloomberg.com; briefing.com; cbot.com; cme.com; federalreserve.gov; treas.gov
Existing home sales: http://www.nar.realtor.com/research
Housing starts: http://www.census.gov/indicator/www/newresconst.pdf
New home sales: http://www.census.gov/const/newresales.pdf

My Notes:
Pg. 11: While there’s no doubt that the Fed is in control of short-term interest rates, the Fed has little control over long-term interest rates. As a result, the interest rate levels on a wide variety of long-term financial vehicles, such as home mortgages, are anchored against interest rates that are set in the bond market. This is what makes the bond market so important to the economy. Its daily fluctuations have a direct bearing on the interest rate instruments that directly affect the economy. In many ways, the bond market is as much in control of the economy as the Federal Reserve is.

Pg. 19: The bond market has become so large that its dollar value now exceeds that of the stock market. Moreover, the bond market has become a bigger source of capital than the banking system.

Pg. 23: The U.S. bond market is the biggest securities market in the world. At $18.5 trillion, the bond market is almost double the size of the U.S. economy and is several trillion dollars larger than the U.S. equity market, which has a market capitalization of about $15 trillion. The bond market consists of many different types of fixed-income securities. The most prominent of these securities are, from the largest segments to the smallest, as follows:
· Mortgage-related securities
· Corporate bonds
· U. S. Treasuries
· Money market securities
· U.S. government agency securities
· Municipal bonds
· Asset-backed securities

Pg. 44: Note that the $100 billion in average daily trading volume of mortgage-backed securities is nearly double the average daily trading volume of stocks on the NYSE. One would never know that by reading the daily financial newspapers, where there is hardly a mention of the mortgage-backed securities market. (note this written in 2001-02).

Pg. 53: The single most important element of successful bond investing is making an accurate assessment of the major fundamental factors that affect the direction of interest rates, the shape of the yield curve, and the level of real interest rates. The factors that affect these key fundamental forces and with which investors should be more concerned include the pace of economic growth, inflation, and the Fed.

Pg. 58: In the U.S. the issuance of bonds in bearer form was disallowed in 1982 as it was felt that bearer bonds could be used as payment for illegal activities, could be used for money laundering, and could be easily stolen and converted into cash without the need to prove ownership.

Pg. 60: The yield-to-worst is simply the lowest possible yield an investor would earn on a bond if it were redeemed for any reason specified in the bond’s indenture, including its call and refunding provisions.

The yield-to-call and the yield-to-worst are like footnotes on the yield-to-maturity and are a must-know when one is buying a bond with provisions for early redemption.
A bond that contains a put provision gives the bondholder the right to redeem the bond, or “put” it, by selling it back to the issuer at par on dates specified on the indenture. Yield-to-maturity traditionally has been defined as the total rate of return that will be achieved on a bond from the date of purchase until the time the bond matures. It takes into account all of the bond’s cash flows, including its coupon income, gains or losses from the difference between an investor’s purchase price and the bond’s redemption value; interest earned on interest; and the timing of each cash flow.
Pg. 70: U.S. Treasuries
The U.S. Treasury market is the most active and liquid market in the world, with daily volume by primary dealers averaging $297.9 billion in 2001. Treasury securities are issued by the U.S. Treasury Dept. to meet the funding requirements of the U.S. Treasury securities are backed by the full faith and credit of the U.S. govt. and therefore are perceived to be free of the risk of default. The deep liquidity of the Treasury market and its risk-free characteristics are the primary reasons Treasuries are used as the benchmark for the quoting and pricing of other fixed-income securities. The Treasury Dept. issues three different categories of Treasury securities: discount, coupon, and inflation-linked.
Pg. 73: In 1997 the Treasury began issuing bonds that provided investors with protection against inflation. These bonds are commonly known as TIPS, or Treasury Inflatin Protected Securities. TIPS are indexed to the Consumer Price Index for All Urban Consumers (CPI-U). As the CPI-U increases, the face value of TIPS increases. For example, if you purchased an inflation-indexed security on its issuance date at a face value of $1000 and the CPI-U increased by 3% over the subsequent year, the face value of the that security would increase to $1030. Assuming the security paid a coupon rate of 3% (it stays fixed throughout the life of the bond), your interest income would rise from $30 per year to $30.90 ($1030 X 3%). Each year the face value would increase along with the inflation rate, resulting in an increase in coupon payments. At maturity, the security would be redeemed at the inflation-adjusted face value of the face value at issuance, whichever was greater.
Pg. 79: Credit ratings are assigned by four major rating organizations: Moody’s Invewtor Services, Standard & Poor’s, Fitch IBCA, and Duff & Phelps. Of the four, Moody’s and Standard and Poor’s are considered the leading agencies.
Government-Sponsored Enterprises (GSE’s):
Pg. 82: GSE’s securities may one day supplant U.S. Treasuries as the benchmark securities of the fixed-income market owing to the size, liquidity, and high credit quality of the GSE market. GSE’s are privately owned companies that were created by Congress to provide funding to important sectors of the economy, including housing, farming, and education. GSEs issue debt to raise capital to lend to prospective borrowers, particularly in the housing market. There are eight government-sponsored enterprises:
· Federal Farm Credit Bank System
· Farm Credit Financial Assistance Corporation
· Federal Home Loan Bank
· Federal Home Loan Mortgage Corporati0on (Freddie Mac)
· Federal National Mortgage Association (Fannie Mae)
· Student Loan Marketing Association (Sallie Mae)
· Financing Corporation
· Resolution Trust Corporation
Note: the Government National Mortgage Association (Ginnie Mae) is still a government agency, not a GSE, so securities are backed by the full faith and credit of the U.S. govt.
Since 1968 Fannie Mae has helped more than 30 million families purchase their own homes. Instead of lending directly to prospective home buyers, Fannie Mae purchases mortgage loans from mortgage lenders such as savings and loan institutions, mortgage companies, and commercial banks.
The yield curve is a chart that plots the yield on bonds against their maturities. The shape of the yield curve is generally upward-sloping, with yields increasing in ascending order as maturities lengthen. In other words, a “normal” yield curve is one in which the yields on long-term maturities are higher than the yields on the short-term maturities. The maturities generally included in yield curve graphs range from 3 months to 30 years. Throughout the years the yield curve has proved to be one of the best economic indicators among the many that exist. The yield curve is thought to be a better predictor of the economy than the stock market is. Studies have shown that the yield curve predicts economic events roughly 12 months or more in advance, while the stock market is thought to foretell events only 6 to 9 months in advance. The yield curve’s powerful predictive value was clearly illustrated in 2000 when the events of that year were forecast by the inversion of the yield curve that began in January 2000.
Pg. 153: On the three prior occasions when the yield curve inverted—1989, 1982, and 1980—a recession soon followed.
Pg. 174: Historically, it appears that real yields on the 10=year T-note generally fluctuate in a range of about 2% to 4% except during extraordinary periods.
Pg. 215: The origin of Fibonacci analysis is quite interesting. Fibonacci is the name of a mathematician who lived in Pisa, Italy, around 1170 to 1240. To investors one of Fibonacci’s most important theories relates to the so-called golden mean, which is basically a ratio that appears to be present in the growth patterns of many things in nature, including petals on a flower, the spiral formed by a shell, and pinecones. Fibonacci discovered a number series from which the golden mean could be derived. Beginning with the sequence 0, 1, 1, 2, 3, 5, 8, 13, 21, etc., each number is the sum of the two preceding numbers. Dividing each number in the series by the one that precedes it produces a ratio of about 1.618034, which is equal to the golden mean. What’s fascinating is that so much of human nature seems to relate to the golden mean ratio.