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1. FIRC
Fixed Income, Rates, and Credit
January 15th, 2014

2. Think FIRC & Think Trading
“Fixed Income” is too narrow of a definition for what we
can invest in for “income” purposes.
Income portfolios need to be looked at on a total return
basis as much as any equity portfolio.

3. Benchmarks & Managers Matter
How much were stocks up in 2013?
• 22% if you invested in DJIA, 25% if you invested in SPY, and 35%
if you invested in QQQ. Big differences based on the index you
track.
• If you move outside the US, the question of how much were
stocks up varies even more.
• What about the last 6 months? Spain’s 39% gain dwarfs the S&P
500’s 10%.

4. Where are Rates Headed?
What rate?
• 10-Year Treasury? Long bond? 3 Month LIBOR? High-yield bond
yields? High-yield bond spreads? Spanish bonds? European
corporate bonds?
What time frame?
• Over the next few days? Weeks? Months? Years? Timing is even
more important in the income world where coupon and interest
payments are an important factor in total return.

5. Where are Rates Headed?
Intermediate Yields
• Stable to slightly lower as the growth story fails to develop
sufficient strength and a steep yield curve slowly drives short
positions out of the market
Credit Spreads
• Tighter as there is sufficient growth to support the market, and
the “chase for yield” encourages structured products in addition
to CLO’s creating greater demand for credit

6. Managing Bond Market Risk
Complex but Simple
• Bonds have their own terminology that is confusing at first, but
you will soon realize it is more about job security for fixed income
professionals than anything that is truly difficult to understand
• Think in basic “building blocks” of risk and you can’t go wrong.
• Fixed Income portfolios can be customized to express risk views
in ways that equity portfolios can’t.

7. Bond Market Risks
Complex but Simple
• Bonds have their own terminology, which while confusing at
first, you will realize it is more about job security for fixed income
professionals than anything that is truly difficult to understand.
• Think in basic “building blocks” of risk and you can’t go wrong
• Fixed Income portfolios can be customized to express risk views
in ways that equity portfolios can’t.

8. Bond Market Risks – Rate And Duration
Rate Risk
• Typically Treasury or sovereign debt risk. The “risk-free” rate.
• LIBOR, a benchmark for short-term rate risk, typically tracks Fed
Funds and Bank Credit Spreads.
• TIPS are traded on a “real yield” where investors can lock in a
real rate of return above CPI.
• Rates are expressed in yield, or bps (basis points), where 1 bp
(basis point) is simply 0.01% in yield terms.

9. Bond Market Risks – Rate And Duration
Duration Risk
• Bonds with longer maturities generally have more interest rate
risk. For a similar change in yield, a bond with a longer maturity
will typically have a larger price move.
• Callable bonds, typical of high-yield bonds and preferred
bonds, cap their upside as they can be called, so they face
“extension” risk where the effective maturity increases as prices
decline

10. Bond Market Risks – Rate And Duration
SHY and FLOT barely move, while TLT has much larger swings than IEF as
the underlying portfolio has a much longer average duration

11. Bond Market Risks – Rate and Duration
This simple table illustrates a lot of what you need to
know about bond “math” or bond pricing
5 Year Treasury
Yield
Price Change
1.20% 101.45%
2.41%
1.45% 100.24%
1.20%
1.70% 99.05%
1.95% 97.87% -1.18%
2.20% 96.70% -2.34%
2.70% 94.42% -4.62%
3.70% 90.80% -8.25%
10 Year Treasury
Yield
Price
Change
2.40% 103.10%
4.39%
2.65% 100.87%
2.17%
2.90% 98.71%
3.15% 96.59% -2.11%
3.40% 94.53% -4.18%
3.90% 90.55% -8.15%
4.90% 83.16% -15.54%

12. Bond Market Risks – Curve Risk
Curve Risk
• Bond yields have changed with the curve “steepening” which
means that longer rates have increased faster than short term
rates.
• U.S. Treasury Yield Curves remain very steep.
• Forward rates have priced in a lot of weakness as the “fair” rate
for the 10 year bond yield in 1 year is about 3.35% or 0.45% than
the current 10 year rate.
• This
process
of
“bootstrapping”
understanding curve risk.
is
a
key
element
of

13. Bond Market Risks – Bootstrapping
How high can 10-year yields go?
• This is a question on everyone’s mind as it is driving the
corporate bond market, mortgages, and some days, even
equities.
• The
10-year
expectations,
rate
inflation
will
be
a
expectations,
function
and
of
growth
Federal
Reserve
Policy, and the shape of the curve.
• While growth and inflation expectations change and investors
have a wide array of views, Fed Policy and the Curve are easier to
analyze, and very important to the bond market.

14. Bond Market Risks – Bootstrapping
Start with the 2-year Bond
• The two year bond has spent the past 6 months trading in a
narrow range: 0.25% to 0.5%.
• The Fed remains committed to keeping Fed Funds, the overnight
rate low for the foreseeable future, in spite of creating negative
real short term rates for longer than any other period in recent
history.
• It seems safe to assume under the current Fed the 2 year yield
should stay stable around 0.40% where it currently is trading.

15. Bond Market Risks – Bootstrapping
Next, Look at the 5-year Bond
• The 2-year bond is at 0.4% and the 5 year bond is trading at
1.7%, towards the high end of its recent range, but well off the
0.65% low we saw last May
• The 2’s 5’s spread is 1.30% or 130 bps. That is high.
• For these rates to be “fairly priced” the 3-year treasury would
have to yield 2.55% in 2 years. The 3-year treasury currently
yields only 0.83%. That is a large rise in yields. So those that say
not much is priced in, are wrong

16. Bond Market Risks – Curve Risk & the 10 Year yield
The 2’s 10’s Spread going back to 1990

17. Bond Market Risks – Credit Risk
Credit or “Spread” Risk is Similar to Yield Risk
• Duration impacts change in spreads the same way duration
impacts changes in rates.
• There are credit spread “curves” which can be steep or flat and
tend to invert if a credit runs into problems.
• High-yield and EM spreads are typically more volatile than
Investment Grade Spreads.

18. Bond Market Risks – Credit Risk
Credit Spreads are often inversely correlated to Treasuries as in an
improving economy makes Treasury yields go higher, but makes spreads
improve. The recent extremely high correlation is unusual.

19. Bond Market Risks and the ETF’s
Market
Short Maturity Treasuries
Intermediate Treasuries
Long term Treasuries
TIPS
Investment Grade Bonds
High Yield Corporate
Floating Rate Notes
Leveraged Loans
Municipal Bonds
Preferred Shares
Emerging Market bonds
Rate
Yes
Yes
Yes
Some
Yes
Yes
No
No
Yes
Yes
Yes
Duration Credit
Low
Low
Medium Low
High
Low
Medium Low
High
Medium
Medium High
None
Low
None
Medium
High
Medium
High
High
High
High

20. A Deeper Look into Leveraged Loans vs High Yield
High Yield Bonds
Credit Risk
High Yield Companies
Interest Rate Yes, average maturity is
Risk
about 5 years
LIBOR Risk
Best Case
Worst Case
Not Directly
Lower yields, improved
credit spreads, with some
M&A Activity for large total
return
Leveraged Loans
Secured Debt of High Yield
Companies
Somewhat as LIBOR floor has
turned many loans into fixed
rate for forseeable future
Due to LIBOR floors most
loans will not see coupon
increases even if LIBOR
increases
Current Coupon since most
loans are callable at or near
current prices
The oversupply due to CLO
Yields rise or we see a return demand comes back to
of real credit risk
haunt the market

21. FIRC Risk Management In Action
YTD Performance based on ETF’s is
0.9% and 1.7% since October 1
launch.
“Beta” selection, whether an ETF or
mutual fund or closed end fund is
critical opportunity to outperform
this basic strategy as we mentioned
earlier – not all indices or managers
are created equal.

22. FIRC Risk Management In Action
YTD Performance based on ETF’s is
1.2% and 2.5% since October 1
launch.
This is designed to be a little more
frequently traded, making it more
difficult to execute via mutual funds
but still something that needs to be
considered as the performance
disparity between top performing
mutual funds and ETF’s grows.

23. Peter Tchir
tchir@tfmarketadvisors.com
Contact Information
TF Market Advisors, LLC
135 East 57th Street, 23rd Floor
New York, NY 10022