Fixed income

By Shivgan Joshi http://stockcreditfinancecfa.blogs pot.com/

Caution
Lots of assumptions In many places TVM is ignored

Developing Intuition
Cash flows: 2012 1 Jan=-100 2013 1 Jan=10 2014 1 Jan=0 2015 1 Jan =100 IRR=? Huge approximation = 3.33% Geometric Arithmetic Bank fixed / depending project US(1.25%) vs India(10%)

NPV vs. PV
Net means minusing and removing

Example
Individual a stand alone company and not bank This is an internal matter

IRR
Internal Rate of Return Inside, in the system, in our model = internet -100 (2012)-- 10(2013), 110(2014) ?? 10%

Price vs Yield
100 110 (IRR=10%) Market Interest rate of similar risk instrument is 8% Market rate for similar is 12% 31 Dec Party = Market Rate was 8% 1 Jan, RBI upheaval = 12% Market rate is not under your control, that means bond price is also not our control We will try to sell to other person and decide the price

Read this on simply simple

PPT of these people are also very good

Yield
Market rates of return on similar instrument Sometime taken as Risk free US treasury bond + spread 100 120 Ours (as market interest rate /yield was 20%) this is our locked cash flows at 31 dec 100 115 Market (now market rate changed to 5%) at 1 jan Then we will sell our instrument at 105 Smartey No arbitrage Price of Portfolio increased

Equilibrium and Adjustments

Price Yield adjusts as things so that no one can make profit Everything remains fair and no on is at loss Price changes with Yield changes

Basics
Fixed Future payments vs interest rates in market CF: 10, 110.. Damn Fixed Yield / Market interest rate (raw definitions)10% --- 20%

Yield vs IRR Same Risk

Internal thing Yield (entire universe with similar risk instrument)

IRR

Duration Intuition
Pay back period vs discounted pay back period 10,10,10,100 (Assume 90 Rs bond) what is payback period? Bond Price vs Face Value

Duration things that requires patience One of the

Macaulay Duration vs. Modified duration Weight time vs. Sensitivity Example from Wikipedia

Convexity
Parameter for right adjust for change in yield to price

References
Wiki