More common sense for buyers

[patientrenter]

Rustico,

What kind of nerd am I? 5’8″, blue eyes, insomniac….

I design and price retail financial products (that are not mortgages). I also initiate opportunistic wholesale purchases of bonds to support a portion of those retail sales. I strongly believe most people should not try to time the bond market for profit. Do it for amusement, but not if you expect to profit from it.

The two rules of thumb I gave for comparing levels of uncertainty about future long bond rates are, unfortunately, about as far as one can go without pulling in far more complex mathematical tools. And the rules of thumb are imperfect simplifications. Sorry.

Where does the square root come from? I said that the amount of unecertainty in a future long bond interest rate roughly varies with the square root of the time from now until that future time, if the time is short enough. Rather than pulling in the general theory, I’ll give a plausibility argument using a simple example. I hope it’s not too mysterious or mathematical. (For those familiar with stats, the key fact is that the standard deviation of the sum of N independent, identically distributed random variables is the square root of N times the standard deviation of one of the random variables.)

Here’s the illustrative example. The change in the long bond rate from now (June 16) to July 16 will be the sum of the daily changes on each of the 20 or so trading days from now until then. We don’t know the change next Monday, but we have some idea from experience how likely an increase or decrease of any amount is. A first approximation to the truth is to assume that the same likelihoods apply to Tuesday and all the other trading days. Another approximation to the truth is that the amount of change that occurs on one day has no impact on the amount of change that occurs on subsequent days (which is clearly not completely true, but look at the results before jumping to conclusions).

Next comes the mysterious math (statistics): The amount of variation in something uncertain that is itself the sum of N other uncertain pieces that all look alike, and that do not depend on each other, is equal to the square root of N times the amount of variation in any one of the pieces. (Read standard deviation for amount of variation, if you like stats)

Applying the math to the daily changes in the long bond rate from now until July 16, a first approximation to the truth is that the amount of possible variation in long bond rates from now until July 16 is the square root of 20 (about 4.5 according to my mental math) times the amount of possible variation we now expect to see on Monday.

So if you are considering a possible 10bp change on Monday, a change of 45bp is about as likely over the next month. I hope that sounds like a reasonable result to you, and it comes in spite of all the imperfections we had to paper over along the way.

How likely is a 10bp move either way on Monday? You can learn more about the likelihood of various amounts of daily change by looking at actual historical daily changes over the last year or longer. (If you’re really interested, a good internet source is the H.15 report updated daily by the Fed.)

OK, that’s probably more than enough technicality for you and 99% of the readers here. Hopefully it shed some light, or at least didn’t give you a headache.

Patient renter in OC

[eyePod]

Regarding using Realtors to represent you. I’m sure SD Realtor is a really good realtor. Unfortunately, this is not a blanket statement that can be made about all realtors. If you do not personally know the Realtor who might represent you, then buyer beware! Some “realtors” out there are very inexperienced and ignorant and do not know how to negotiate for you (or don’t want to).

[eyePod]

Regarding using Realtors to represent you. I’m sure SD Realtor is a really good realtor. Unfortunately, this is not a blanket statement that can be made about all realtors. If you do not personally know the Realtor who might represent you, then buyer beware! Some “realtors” out there are very inexperienced and ignorant and do not know how to negotiate for you (or don’t want to).

[NotCranky]

Thanks Patient,
I think there are probably more like 5% who easily assimiliate your topic and the dreaded math. I don’t but with a small study could. Mostly I am trying to get an idea of what would be a more or less extreme case of fluctuation for the yeild over various periods of time and that could probably easily be obtained from historic charts now that I think of it. A big draw to this blog for me is that there are many people who have expertise in the financial world and areas of Real Estate that your’s truly has not yet participated in or studied.

It is interesting that you include your height. I wonder if that is related to some post I made to another fellow here on the blog. I was teasing him because he said I was “sensitive” for “a big guy”. LOL. Because he invoked this comment, I thought he might have a little chip on his shoulder about his stature. He confirmed that he did not so I will have to find a different chink in his armor!I am not arrogant about my height or dismissive of others based on it.

I like your style and contributions Patient.
Have a good day 🙂

[NotCranky]

Thanks Patient,
I think there are probably more like 5% who easily assimiliate your topic and the dreaded math. I don’t but with a small study could. Mostly I am trying to get an idea of what would be a more or less extreme case of fluctuation for the yeild over various periods of time and that could probably easily be obtained from historic charts now that I think of it. A big draw to this blog for me is that there are many people who have expertise in the financial world and areas of Real Estate that your’s truly has not yet participated in or studied.

It is interesting that you include your height. I wonder if that is related to some post I made to another fellow here on the blog. I was teasing him because he said I was “sensitive” for “a big guy”. LOL. Because he invoked this comment, I thought he might have a little chip on his shoulder about his stature. He confirmed that he did not so I will have to find a different chink in his armor!I am not arrogant about my height or dismissive of others based on it.

I like your style and contributions Patient.
Have a good day 🙂

[2Buy-or-Not2Buy]

SD R,

Thanks for starting this thread. This is one of those times when the old saying “no good deed goes unpunished” seems appropriate. I appreciate your contributions to the board and think that you do a great job of providing very helpful, practical information. You have also been clear from the beginning (user name and all) that you are a realtor, so it should come as no surprise that you bring that to the table. So, please keep doing what you are doing. Those of us who find value in your posts will continue to read them. Those who do not find value in your posts can ignore them. It is still a free country after all.

[2Buy-or-Not2Buy]

SD R,

Thanks for starting this thread. This is one of those times when the old saying “no good deed goes unpunished” seems appropriate. I appreciate your contributions to the board and think that you do a great job of providing very helpful, practical information. You have also been clear from the beginning (user name and all) that you are a realtor, so it should come as no surprise that you bring that to the table. So, please keep doing what you are doing. Those of us who find value in your posts will continue to read them. Those who do not find value in your posts can ignore them. It is still a free country after all.

[SD Realtor]

Thanks to all who participated in this thread. I think it was a good one and best of all it was amiable all the way through. Patientrenter, Alex, Rus, good stuff all the way around. Patientrenter as my real job is a digital design manager I thought your tracking mechanism was excellent. I sucked in stats so I could feel the fog rolling in on my brain as I read your reasoning… What I really wanted to point out, without being able to explain it mathematically was that you could make approximations for the upper and lower bounds of the where the long bond may be in the future, say at least a month from now and then make worst case and best case approximations of where your loan “could” be at if you did have to float it…

I think one thing we all agree on is… “don’t float your loan rate!!!”

Which is like impossible to do if you are buying a phase release from a builder that will not be completed for a few months….

SD Realtor

[SD Realtor]

Thanks to all who participated in this thread. I think it was a good one and best of all it was amiable all the way through. Patientrenter, Alex, Rus, good stuff all the way around. Patientrenter as my real job is a digital design manager I thought your tracking mechanism was excellent. I sucked in stats so I could feel the fog rolling in on my brain as I read your reasoning… What I really wanted to point out, without being able to explain it mathematically was that you could make approximations for the upper and lower bounds of the where the long bond may be in the future, say at least a month from now and then make worst case and best case approximations of where your loan “could” be at if you did have to float it…

I think one thing we all agree on is… “don’t float your loan rate!!!”

Which is like impossible to do if you are buying a phase release from a builder that will not be completed for a few months….

SD Realtor

[NotCranky]

Happy father’s day Adam.
Thanks for your patience with me . You are the best.

[NotCranky]

Happy father’s day Adam.
Thanks for your patience with me . You are the best.

[patientrenter]

Rustico,

You’re correct about the height. I think you were ribbing jg (whom I don’t know).

I thought it was a bit unfair of me to drag you through all that math and then leave it up to you and others to do the last step to get practical numbers you can use. So I went to that h.15 report I mentioned, which has daily closing data from 1962, and measured the historical variation in 10-year Treasury rates. Here are some results that might cut through the fog:

1. 90% of the time, the change in the 10-year Treasury rate since the last trading day (using closing prices) is 10bp or less, in either direction.

2. 99% of the time…. 25bp

To get variations over one month, just multiply by 5 (so changes are 50bp or less in either direction 90% of the time, and 125bp… 99% of the time).

If you’re looking at X months, multiply the monthly bp values above by sqrt(X).

At any one time, interest rate volatility can be higher or lower than the average from 1962 until now. Even our recent volatility in the bond markets is less than the average for 1962-2007, because the average includes lots of volatile years from the 1980’s. You could use 50-90% of the amount of variation quoted above in today’s environment. It’s been closer to 90% in the last few weeks, and was 50-60% for most of the last year.

SD R, I agree totally that the main point of all this is to have some awareness of this inability-to-lock-in risk (and thanks again for being the one to contribute that to us all).

Back to real estate, and over and out.

Patient renter in OC

[patientrenter]

Rustico,

You’re correct about the height. I think you were ribbing jg (whom I don’t know).

I thought it was a bit unfair of me to drag you through all that math and then leave it up to you and others to do the last step to get practical numbers you can use. So I went to that h.15 report I mentioned, which has daily closing data from 1962, and measured the historical variation in 10-year Treasury rates. Here are some results that might cut through the fog:

1. 90% of the time, the change in the 10-year Treasury rate since the last trading day (using closing prices) is 10bp or less, in either direction.

2. 99% of the time…. 25bp

To get variations over one month, just multiply by 5 (so changes are 50bp or less in either direction 90% of the time, and 125bp… 99% of the time).

If you’re looking at X months, multiply the monthly bp values above by sqrt(X).

At any one time, interest rate volatility can be higher or lower than the average from 1962 until now. Even our recent volatility in the bond markets is less than the average for 1962-2007, because the average includes lots of volatile years from the 1980’s. You could use 50-90% of the amount of variation quoted above in today’s environment. It’s been closer to 90% in the last few weeks, and was 50-60% for most of the last year.

SD R, I agree totally that the main point of all this is to have some awareness of this inability-to-lock-in risk (and thanks again for being the one to contribute that to us all).

Back to real estate, and over and out.

Patient renter in OC

[NotCranky]

Thanks again “patient renter” your post is very educational.

[NotCranky]

Thanks again “patient renter” your post is very educational.

[Author]

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