Professional Documents
Culture Documents
Chapter 14
Bond Characteristics
16-2
1-2
Different Issuers of Bonds
U.S. Treasury
Notes and Bonds
Corporations
Municipalities
International Governments and Corporations
Innovative Bonds
Indexed Bonds
Floaters and Inverse Floaters
16-3
1-3
Provisions of Bonds
Secured or unsecured
Call provision
Convertible provision
Put provision (putable bonds)
Floating rate bonds
Sinking funds
16-4
1-4
Bond Pricing
PB C t
ParValue T
(1 r )
T
t 1 (1 r )
t
16-5
1-5
Price: 10-yr, 8% Coupon, Face = $1,000
20
1 1000
P 40
1.03
t 20
t 1 (1.03)
P $1,148.77
Ct = 40 (SA)
P = 1000
T = 20 periods
r = 3% (SA)
16-6
1-6
Bond Prices and Yields
16-7
1-7
Prices and Coupon Rates
Price
Yield
16-8
1-8
Yield to Maturity
PB C t
ParValue T
(1 r )
T
t 1 (1 r )
t
16-9
1-9
Yield to Maturity Example
20
35 1000
950
(1 r )
T
t 1 (1 r )
t
16-10
1-10
Yield Measures
16-11
1-11
Realized Yield versus YTM
Reinvestment Assumptions
16-12
1-12
Holding-Period Return: Single Period
HPR = [ I + ( P0 - P1 )] / P0
where
I = interest payment
P1 = price in one period
P0 = purchase price
16-13
1-13
Holding-Period Example
16-14
1-14
Holding-Period Return: Multiperiod
16-15
1-15
Default Risk and Ratings
Rating companies
Moody’s Investor Service
Standard & Poor’s
Duff and Phelps
Fitch
Rating Categories
Investment grade
Speculative grade
16-16
1-16
Factors Used by Rating Companies
Coverage ratios
Leverage ratios
Liquidity ratios
Profitability ratios
16-17
1-17
Protection Against Default
Sinking funds
Dividend restrictions
Collateral
16-18
1-18
Default Risk and Yield
Default premiums
Yields compared to ratings
16-19
1-19
The Term Structure
of Interest Rates
Chapter 15
Overview of Term Structure
16-21
1-21
Yield Curves
Yields
Upward
Sloping
Flat
Downward
Sloping
Maturity
16-22
1-22
Expected Interest Rates (Table 15.1)
16-23
1-23
Pricing of Bonds using Expected Rates
1
PVn
(1 r1 )(1 r2 )...(1 rn )
16-24
1-24
Bond Prices using Expected Rates
16-25
1-25
Forward Rates from Observed Rates
(1 yn ) n
(1 f n )
(1 yn 1 ) n 1
(1 yn ) n (1 yn1 ) n1 (1 f n )
16-26
1-26
Example of Forward Rates using Table 15.2
16-29
1-29
Theories of Term Structure
Expectations
Liquidity Preference
Upward bias over expectations
Market Segmentation
Preferred Habitat
16-30
1-30
Expectations Theory
16-31
1-31
Liquidity Premium Theory
16-32
1-32
Liquidity Premiums and Yield Curves
Forward Rates
Liquidity
Premium
Maturity
16-33
1-33
Liquidity Premiums and Yield Curves
Yields
Observed Yield
Curve
Forward Rates
Liquidity
Premium
Maturity
16-34
1-34
Market Segmentation and Preferred Habitat
16-35
1-35
Using Spot Rates to Price Coupon Bonds
16-36
1-36
Sample Bonds
A B
Maturity 4 years 4 years
Coupon Rate 6% 8%
Par Value 1,000 1,000
Cash Flow in 1-3 60 80
Cash Flow in 4 1,060 1,080
Assuming Annual compounding
16-37
1-37
Price Using Spot Rates Bond A
Spot Cash PV of
Period Rate Flow Flow
1 .05 60 57.14
2 .0575 60 53.65
3 .063 60 49.95
16-38
1-38
Price Using Spot Rates Bond B
Spot Cash PV of
Period Rate Flow Flow
1 .05 80 76.19
2 .0575 80 71.54
3 .063 80 66.60
16-39
1-39
Solving For Yield to Maturity
Bond A
Bond Price 978.54
YTM 6.63%
Bond B
Price 1,047.56
YTM 6.61%
16-40
1-40
Managing Bond Portfolios
Chapter 16
Basic Strategies
Active strategy
Trade on interest rate predictions
Trade on market inefficiencies
Passive strategy
Control risk
Balance risk and return
16-42
1-42
Bond Pricing Relationships
16-43
1-43
Bond Pricing Relationships (cont’d)
16-44
1-44
Duration
16-45
1-45
Duration: Calculation
t
wt CF t (1 y ) Price
T
D t wt
t 1
16-46
1-46
Duration Calculation: Spreadsheet 16.1
16-47
1-47
Duration/Price Relationship
16-48
1-48
Rules for Duration
16-49
1-49
Rules for Duration (cont’d)
16-50
1-50
Duration and Convexity
Price
Pricing Error
from convexity
Duration
Yield
16-51
1-51
Correction for Convexity
1 n
CFt
Convexity
P (1 y ) 2
(1 y ) t (t t )
t 1
2
Correction for Convexity:
P
D y 1 [Conveixity (y ) 2 ]
P 2
16-52
1-52
Passive Management
Bond-Index Funds
Immunization of interest rate risk:
Net worth immunization
Duration of assets = Duration of liabilities
Target date immunization
Holding Period matches Duration
16-53
1-53
Active Management: Swapping Strategies
Substitution swap
Inter-market swap
Rate anticipation swap
Pure yield pickup
Tax swap
16-54
1-54
Yield Curve Ride
Yield to
Maturity %
1.5
1.25
.75
Maturity
3 mon 6 mon 9 mon
16-55
1-55
Contingent Immunization
16-56
1-56
Interest Rate Swaps
16-57
1-57
Swap Example Figure 16-11
6.95% 7.05%
7%
Swap
Company Company
Dealer
A B LIBOR
LIBOR LIBOR
16-58
1-58
16-59
1-59
16-60
1-60