Professional Documents
Culture Documents
Lecture17 PDF
Lecture17 PDF
Management
Fall 2020
Farzad Saidi
600
500
Equity
400
in USD bn
Treasury
300
200
100
2000 2002 2004 2006 2008 2010 2012 2014 2016
1
U.S. bond market trading volume
600
Municipal
Treasury
500 Agency MBS
Non-Agency MBS
ABS
400 Corporate Debt
in USD bn
300
200
100
0
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
2
U.S. bond market issuance
3
Bond characteristics
4
Typical covenants
5
Treasury notes and bonds
6
Accrued interest
7
Corporate bonds
8
Bond prices
Semi-annual coupons:
2T
X $C $Par
P= t + 2T
t=1
(1 + r /2) (1 + r /2)
Annual coupons:
T
X $C $Par
P= t + T
t=1
(1 + r ) (1 + r )
Example:
Example:
10
Yield to maturity: example
Suppose that
Questions:
11
Bond prices and yields
1000
900
bond price
800
700
600
0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
yield
12
Premium and discount bonds
Premium bond:
C > YTM
Bond price declines over time to par by maturity ⇒ otherwise would
receive too high yields
Discount bond:
YTM > C
Bond price increases over time to par by maturity ⇒ otherwise
would receive too low yields
13
Premium and discount bonds
14
Zero coupon bonds
Catastrophe bonds:
Indexed bonds:
16
Term structure of interest rates
Yield Humped
Normal
Flat
Inverted
Maturity
17
Theories of the term structure
Expectations theory:
The key assumption behind this theory is that buyers of bonds do not
prefer bonds of one maturity over another, so they will not hold any
quantity of a bond if its expected return is less than that of another bond
with a different maturity
Note that what makes long-term bonds different from the short-term
bonds are the inflation and interest rate risks. Therefore, this theory
essentially assumes away inflation and interest rate risks
r1 = 8% E (r2 ) = 10%
(1 + yn )n = (1 + yn−1 )n−1 × (1 + fn )
Example:
20
Example
Given the following term structure, what are the implied forward rates?
21
Term or yield spread
3
in percent
-1
1980 1985 1990 1995 2000 2005 2010 2015 2020
Under the assumption that the annual coupon is $100, the par value
is $1,000, and the maturity is 3 years, what is the price of the
coupon bond?
What if we assume that the term structure is flat at 10%?
24
Summary
This class:
Next class:
Duration
Bond portfolios
25