Tad Borek <borekfm[at]pacbell.net> wrote:

- quote -

A couple of months ago, I wrote that I would be "shocked" by a drop in interest
rates. I no longer would be shocked. If the current soft spot in the economy
gets softer, interest rates are likely to drop.

-- Doug

Thanks for the very informative answers, Tad and Rich. I was not
aware of the concept of duration. I have googled some other pages on
that and will take a closer look at the math behind it. This adds
clarity to my original question regarding how the author made money in
those particular years by buying 30-yr zeros. He was essentially
betting on significant interest rate drops.

-tom

Tad Borek <borekfm[at]pacbell.net> wrote in message news:<chqWc.7187$QJ3.3328[at]newssvr21.news.prodigy.com> ...
- quote -


======================================= MODERATOR'S COMMENT:
Please trim the post to which you respond.

tom wrote:
- quote -

Yes but I have to editorialize a little...in #2 your scenario is
"interest rates drop" and I'd say "in a development that would stun bond
investors, the already pathetically low long-term interest rates drop to
even lower levels."

Point being, given current long-term interest rates, I would emphasize
the risks of what happens when interest rates rise, not the benefits
when they drop.

I guess though if you're looking at a general strategy over time then
it's worth considering the "when rates drop" scenarios - yes, those are
the times STRIPs gain value.

- quote -

Rich gave the precise answer & can do a better job of explaining it the
math side of it than I can. As he pointed out the difference is the
bond's "duration" which is a measure of how long-term a bond is, which
in turn is a measure of the bond's sensitivity to interest rate changes
(how much it'll rise/drop in value as rates change).

Descriptively...duration isn't the maturity of the bond ("20 years"),
but rather a time measure that weights all the payments you receive from
the bond - both the coupons along the way and the face value of the bond
that you receive at maturity. If you want to calculate duration
precisely, Rich gave a formula & you can google around and find duration
calculators.

Because a STRIP has no coupons (interest payments - they've been sold to
another investor) then the duration equals the term of the STRIP. But
for all other bonds your stream of payments looks different and so
duration is less than the term. Example, compare say a $10k bond paying
5% coupons (pretend it's once per year) and its STRIP:

$500 $500 $500....<---30 yrs--> .....$500 $500 $500+$10,000
vs. the STRIPped version of the bond:
...................<---30 yrs--> ....................$10,000

[If you're physics-ally inclined you might like the analogy of a 30-inch
beam with a weight on it at every inch, at each payment...coupons being
500g & maturity being 10000g...the duration is the center of mass of
that beam.]

Now think of "interest rate risk" in the most practical sense which is
"how long might you have to sit on your hands while everyone else is
earning better interest rates?" The STRIP holder waits 30 years. The
normal bond holder at least gets those $500 coupons which could either
be spent or reinvested at the new, higher rates. And for the two-year
bond holder remember it looks like this:

$500 $500+$10k

which is less risky because you only need to sit on your hands for 2
years, not 30 years, for your $10k.

A nice rule of thumb is that every 1% change in interest rates results
in a (1% X Duration) change in the value of the bond - roughly, it's not
precise. If rates go from 5% to 7%, a bond of duration 2 falls in value
by 2%x2=4%. A bond of duration 12 falls 2%x12=24%. A bond of duration 30
falls 2%x30=60% (not exactly but you get the point). Now who says bonds
are conservative investments?

Of course this works both ways. If you bought STRIPs when Treasury bond
rates were at 14%+ you made a killing - you locked in that rate for 30
years, in effect. If you'd opted for "less risk" and bought a two-year
bond at that time, then when it came time to reinvest your $10k two
years later, and two more, and two more, you ended up earning a much
lower interest rate.

Again though today I'd emphasize how low long-term rates are compared to
historical averages. Not much room to go down.

-Tad

tomster71[at]mailcity.com (tom) writes:

- quote -

Yes.

- quote -

It's longer-term.

- quote -

Because zeros (by definition) do not throw off interest. A 30-yr zero
has a duration (not to be confused with maturity) of 30 years. But a
30-yr bond that actually pays interest will only have a duration of
15-20 years (or even less, if it has a high coupon).

If you want to look at it mathematically, if a zero has N years
to go until it matures, then its current price is given by:
P = F/(1 + y)^N
where
P = current price
F = face value
y = yield to maturity
N = number of years to maturity

If you plug some numbers into the equation (or take partial
derivatives of P with respect to y and with respect to N),
you'll see that the bigger N is, the more P will swing with
changes in y.

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

- quote -

Thanks for the reply again, Tad.

Let me see if I can guess how this works.

1. I buy a 30-yr zero today at a certain price, that when calculated
(say x%), give me some rate of return if I hold it to maturity. Based
on my buying it today, I feel that x% is a good rate of return.

2. Interest rates drop, making my x% look better today than
yesterday, thus driving up the price of my 30-yr zero.

Is this right?

If so, I have two follow-up questions:

1. What makes a 30-yr zero more attractive/sensitive than, say, a 10
or 20 yr zero?

2. In general, why is a zero more attractive than any other bond that
would behave similarly (interest rates drop, making prices rise)? You
state above that a small change in interest rates causes a large
change in zero prices (relative to other bond instruments, I'm
assuming). Why is that?

Thanks again.

-tom

Tom wrote:
- quote -

Tom-
The quick answer: go here after reading the next paragraph, it's a graph
of historical rates on 30-year bonds...
http://research.stlouisfed.org/fred2...GS30YR/115/Max

Every time the blue line went up, STRIPS dropped a lot in value. Every
time the blue line went down, STRIPS gained a lot in value. The higher
up the line was, the more of a chance you had to make a killing in
STRIPS. So you can see that the early 1980s was a unique time because
the blue line went as high as it's ever been. And the dates you mention
are times that the line went down very quickly (in part because it had a
long way to drop).

STRIPS represent a very aggressive bet on long-term interest rates. You
buy them if you think rates are dropping, because they'll go up a lot in
value. You avoid them if you think rates are rising, because small
changes in long-term interest rates produce large changes in the value
of a STRIP. Maybe that's what you want to do, but be aware of how
they're valued.

Let me know if you want the long answer.

- quote -

Some mortgage rates (ARMs, adjustable rate mortgages) are based on
interest rates reported by the Federal Reserve Bank. The things you
mention are some of the things that mortgage rates are pegged to. These
are set by market demand and reflect "today's" interest rates. The
One-year Constant Maturity Treasury rate is the current yield for a
Treasury bond that matures in one year. The Five-year is that day's rate
for a five-year bond. When you graph all of these rates you end up with
a chart called the "yield curve". If you google all these terms or look
around on the Federal Reserve sites you'll find a lot of info describing
exactly what they all mean and how they're calculated and reported.
Though if you do all that you can't go calling yourself a newbie anymore!

-Tad

Ron Peterson <ron[at]shell.core.com> wrote in message news:<10h0mt6n4avrsb8[at]corp.supernews.com> ...
- quote -

Thanks, guys for the responses. I'll check out the references you
list.

Tad - quick followup to some of your points:

1. I believe that the author actually does manage money. Doing a
quick google search brings up a claim that he manages $200M.

2. Regarding your question on long-term zeros when rates are low...
looking at his back-tested restuls (to 1972), the 30 yr zeros did
amazingly well in 1982, 1985, and 1995 (156% ,107%,and 85%) as well as
doing pretty well in other years. For the 1982 and 1985 results, I'm
not sure if macro-economically speaking, this is somehow related to
recession-ish stuff? He doesn't give much analysis regarding why
stuff did well.

3. Thanks for the comments on yield to maturity, coupon yield, etc.
Looking at Barrons MW section, under "Bonds", there is a long list of
all sorts of notes and bonds with different maturity dates. I believe
that the yield there is yield to maturity. Now, under the Barrons
Market Lab - Economic Indicators section, there is a subsection
entitled "Adjustable Mortgage Base Rates" and there is a list that
includes a few t-bills and t-notes with some "rate" listed. Under,
there is some small type saying, "fed annualized yields adjusted for
constant maturity" Any idea what this refers to?

Thanks again for the responses.

-tom

Tom <trtsao[at]gmail.com> wrote:

- quote -

Look at web site: http://www.forecasts.org/data/index.htm

--
Ron

Tom wrote:
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The title makes me gag but a simpler point is that if you just split
your money into 1/3s and invest in cash, bonds, stocks you don't do so
bad. I wouldn't count on beating the Dow, but your money will grow.

If he's got some scheme for shifting from one to the other
"mechanically" I'd suggest moving on to another book. Those strategies
are a dime a dozen. If his worked he would implement it with huge
amounts of money (or leverage - borrowed money) instead of selling a
book about it and scoring a lousy $30k advance.

You mentioned zeros - I hope he explains the risks associated with
buying long-term zeros when interest rates are low?

- quote -

One source - at a library look for a book called "Stocks Bonds Bills &
Inflation" by Ibbotson. You can also order it but it's expensive.

I think if you dig around on the US Treasury site you'll find some info
as well.


- quote -

Without seeing exactly what quotes you're talking about...keep in mind
that for every bond there's a coupon rate and a yield (to maturity) and
those are different things. A bond might pay a coupon of 4%, eg $40 per
$1000 face value. But if it sells for $1,122 or $985 on the market the
yield will be different than 4%, even though the coupon is still $40.
The 1122 bond will be redeemed at 1000 (at maturity) and that needs to
be factored into things.

Try Yahoo for current, basic, bond-yield info. Or the daily Wall St Journal.

- quote -

IMO gold prices are an indication of
a) jewelry demand in India (largest single use of gold last I checked)
b) number of gold-related info-mercials on late night TV
c) latest "Franklin Mint" offering in Parade magazine
d) whether gold is the commodity-of-the-week in Chicago
e) whether the stock market went down and people have forgetten a) though d)

As an inflation indicator it's terrible. From a point in 1979 to another
in 1999 - 20 years - gold's price change was exactly 0%. Over the same
period inflation was about 240%. And that was before the price spike, it
got worse...from 1981 to 2001 gold actually dropped about 50% in value
while consumer prices increased a similar 200%+.

The basic problem is that gold doesn't have a role in any significant
economic activity. So its price is based on nonsense...speculation, really.

-Tad

Hello All -

I just read the book "Beating the Dow with Bonds" by Michael
O'Higgins, and his thesis (mechanically choosing between stocks, 30-yr
Zeros, and 1-yr T-bills for asset allocation once/yr) is quite
interesting to me.

But I had some questions I hope somebody can answer.

1. Does anybody know where I can find historical US T-Bond and T-Bill
price and rate data? Let's say, going back 20 or 30 years?

2. One of the calculations involves looking at today's 10-yr US
T-bond Yield to Maturity. If I look at the July 30 Issue of Barrons,
I can see that an Aug 14 bond has an ask yield of 3.75%, but if I look
at the Aug 1 LA Times business section, under key rates and yields, it
lists a 10-yr treasury security as having a rate of 4.47%. Can
somebody explain the difference?

3. Another calculation O'Higgins does is to compare the gold price
today vs a year ago. Can somebody postulate as to the importance of
this? I'm guessing that gold price is an indicator of inflation...
which then gives an indication of whether a short term t-bill or a
long term t-bond will be better over the next year?

TIA.

-tom