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    8 views16 pages

    Chapter 4 (I)

    Uploaded by

    Sh

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
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    of 16
    VVC IIIA GSO SG SEES OVS VW CHAPTER- 4 | Te Term Struclure of Interest Rates: The Yatelol Core :- A yell curve tx a graph or cure where we blot the yells of bonds agaist maturite value. The slope Of the yell curve giver an idea of foto inferet vale cRanger ard economic acuity. There are thre. main types of pice! conve ‘sRaper: (1) Normal yield curve (upword Htobing curve) | (i) Tnverted yids curve ( downward sloping Curve), (ii!) Flat yi cone. | As ‘a general vrule , dong bonds (bonds wsith vers clicdant mafurite data) tend to offer RigRec gieds than fort bends (bonds uit shorter maturity dates) of the same quest. C1) Nowa Yuidd Curve- A normal or up-sebedl pred curve indecates yreds on donger-term bow map continue do mite, (eae o 3 10 1s 2%eeat radon te tome esborcling to pevieds of economic For the fur disceunt bond the shot rate is equal to ids give. Exam = Sap ore Consider a pure cbicoumt bond that uscal mature fn six months. (A six-menth zor coupon bond). Subpete price Lf98 aed ard nomial value ov face volue 1h fie, 98 loo, © 6 months The the annualrzed compound vale Yq th olfained of foAlout > ° t > > | 38 = [iF ¥ FD em = 041233 =z 461283 Y. 3 Six month spot rote ls $-1933. 7. In ths con, we Rae used the sI¥ month compounding convention 3 However, in practre, the simple vate convention Tybtealtg ped, According to this, the Imbbelt yale off return i calecdated as follows: fees 2 . are? : > F =0.0L640 ; or oY = Oboy, Thi Is the Infeesd woke applicable for 6 montBe. Therefore 6- month anmuabzed meet rate = gy 2.040 7, = hogoy, Scanned with CamScanner this the equivalent annual mtexst vate, Exampue, Comsider a bond uit two. yew madd tans Properties of the bond i oy foUous : (1) Bond is pure dltecount bond - CH) Price of the bond is MA $91. G7) Nominal ef the bind & d100, Then two year spot vale Yoy 1 obtained of follows: ay = tee ('%)" DY) = 0.049295 = 49286 y, oy Using simble thierat rate /- 9 loo jae 3 Y = 0:09990| 9+B901 y, According do the cimbke aw tyteat rate convention > Hus i the Intorert rrate for twe can.“ Thovefore inte 2 vat rade one ycer Ry f t = OF K9-B9o1y, = 49461 7, Accorclmg do the Rook.’ Spot vada is the basic rtret rotes ck fing The torm sdructune , The spot vate 2, 1 the wate Of Pnkvet ex Range for Monee, eld from the pened th yorrly terme present time (to) undid time £. Both the inlerett rate and the orginal brine pal aie Scanned with CamScanner PPLAALLAALRAALLRALDLPSSDSPP III IISIAS VEO OUP EEE SRO OCT OCTVTTS USD pasd ot time t. Hence 4% is e vate. for money. Bed bear. | In porticway, Ri the vate paid for moneys Red £ year: Sa tk the vate par for money Aual 2 year; austen) Ad is exprened on an annualized basis. thus, sf qoor banp promizes to boy a vote of %, fora ayear Aeposit. of an amount ‘A’ compounded yearly ot wut) actualy repay (14+3,)"A ab the end of twe- years. a A on teo tet a yo eS (itssy'a gee $21 tan Be ae af as bes) te0 tel fen ra Now we Ud the various porwibilie of combamdng 01) Yearely :- Under the yor compounding convendion, money will grow by the factor : € (i+ 5) . after + years. where 4p i the Spot vote anol £ must be an mcger , or an adgust mod mut be made. (ir) m_ pertads per year :— Under Ye 4 conven of company, YS nn periods per year, the spot rake 8 defyned so that Scanned with CamScanner Money wu grow by the footw. (rs) whee mt must be an rakeaer , so ¢ must be an sntegrot mw t ple of Ven (i) Lenkimuoes Compounding Uncler te cont quay compounding Conuension, the spet wate % is define! so that money. catty pow 4g tthe factor ett for a voluy of ¢. Spot vote curve: Simee a Ze10-coupor Lond promis do ba @ fixcol amount at a fired date in future, spot vate , Theos Can be measued by recording the gles of Zee-coupon bonds, the valio of the Payment amount to the Wrrent prite defines the shot vate for te matuntty, date of the bond. By tie measem- ment procex we can ckuelop 9 spot vale cume , which ~y. | analogous to the ie curve: Se the following. chta and | aePm PPPPPPPPPPRARRAA PAAAAPILAP AANA SSSA Yet spot vats, toe Spi nate i. | 6-61 i 9-083 * a [| ae a 3 [65 | 13 2-365 qe 6998 hen, 9.520 5 436! Is 9-666 é tHE le 9. 789 + ec TA 9-404 8 304 | Ie 19-608 eZ Bae [3 | lores aig | BRS | 88 tee eg Scanned with CamScanner DVO 5.00 UE ODE UI OO OEY SS GE EG. Spot role cure — Distount factors: the dicount factor by which future cach plows must be wut multiplied to obtain an equivalent presen) value. For the various combound ng. conventions , they, ane de frre! 04 folloos th) Yeardy For wey compounelona cis court factor 1 een Eee oh ~ (Ff Suppox we Rowe a casts flow sheam (Ho) 5%, 1%) then 2% q is , ay L | | \ 145, 4a as des b+ 4, \ itn ) (H3sy° Ort ™ periods ber years For coerpurrlone, Mm ‘penvools - por yor Scanned with CamScanner diveoundirg, fortr for kth cath fol & : 1 Te ye - ata) © (For wntnuors Compounding: For conlinuons ener discount factor ait bite tir for cash flow ad ab tment Is eset a = Present Value: let (6, 2p My +s %m) be ang cath flocs shear, of some rmvertment. Then present value of this Gigh fhe steam 14 PV = Mot AMA + AaB. HA nOly . The discount factor de acts Lhe a price for cath recetvol ab hme b, We determine tHe value of a stream by aatting up " pre time, quanti tag for all the cas, compononls of the shea ; Examples EY Fimo! Petont valve of BY. Coupon bond with 10 ¥) maternity time. wth following & bark. yes Tr [oo 3 [+ [sl elele 3[e} shot rate 6.574 [oess $556 [ems [ese [Fat ene [eee ia eons, 4 YUN LA LLAAADADPASAAASSHS TPH Ls We cam prepare @ cash-flow steam 04 followe: — S (9) 3,9,%,8,3,%, 9, &, 6 168) (s ft vale = ps = clicoamnt acter: bi fe = > AIY bili 4 rs , x Scanned with CamScanner DAVY IEEE ETO ST evvvrvvwTwe an a ee Cash ioe py 1 O-OSS HI 0-944 3 P58 | o | 006088 0889 3 eu 4 | 606555 0. 82p 2 661 | ¢ | 0.06979 0 Fit g a | 5 | OOFS] 6: Fol 8 5-6] | & | 0:04F0 4 ae 38 sh yp | 6:0%020 0-583 3 $b q | o-ob sot 0.528 3 ae 9 | 60-0856) O44 3 Fn | Jo 0-OLF9S 6-443) 10 W5o aed a alii feaq pete a ote ect reg og ("148 1400557 peossg, ~ OFF a ot ls = O48EH = oO. = (Itey ~ (rebose )> amc eo 2 = oe Bie (145, f (1.06885) + dpe -b os ! = OFbt ie (145+ J* (196988) F ts gy ule ES ope] oO (is a (1-6#361)" : d,2 51 ! ote f° (tse J . (letter 4 = Scanned with CamScanner —— fet” (ising ee 4g = fry* = Froid 3 ote Day ~ Goeastny = dp = Gaye [roses J" > 0-43) PV = Me +A UAH => Ht Myy ny + Indn = Gd, 4 da to F %GIQ t Heo Cay = 9d + bh be + Bd + 108-9 = PSEA FIA EOLA AU A SLI ASD + 466 + 4214300 + 46-50 5 OF 3+ Example 42:- Sea the book boge no. FL. Determining the Spot rates. the shot vale curve can be determinec! from the ricer of coupon bearing hovols by begning tuith skort matur't'es anol worping. forward foward Jonge merits, We sUushate the foocex for do year Compourcls Conuention ancl acing that coipors are fart ont ye Mi ome q Frat determine 9% by duvet observation of the One-year interes} nate; for exampte , as deterrninech bg the 4 rfeor Treare bat rate. r Scanned with CamScanner ae PLPLRLALAAPRPLALARLALPAPDLADADAASAS SSAA S. VOVVISOVOV VO OUVVOVOVDOTOOOOOGCOOOOEESH Next , consicer two year, bond » Suppo thot bend Fos price P, ropes coupon payment C at the end of boa years, and Ra, a face volue F Then cash feo is: (c ,C+F) ard price should equal to the cliscounted value of the. 176 ftow steam. thod iu, a CHE + ay IS 7) Ps Stmce 4 is prow, we can frnd 4, - Now if we consider three year bord usith coupon cl ond foec volue F' we Rave . ct c e+e! * esis 7 Gay GaP As we prow the valuy of § ond Swe cam frad gy 5 Srenidovle » we cam find 84) S¢5:-- step by step. #& Spot rates can abso be determined by a subtraction proce. Tue bonds of different. coupon vater but identical modurity, dates can be used to conshuct the equivalent of a zen -coupon Lord. Example: - Supbise we Rave two bonds, Berd A a Jo- year “bond with a lov. Cupon.amd price fy =$93-42. Bond B is a lo- year bond uth a 97. coupon and price Fy, =$Q5-39. Both hond Rove same face value foo, Consider a portfolto usith 6 unit of bond A and 1 unitof lord &, Them forlfebio face value of thu portfolio de cam be calewake!l Farer 05 follows; Scanned with CamScanner Face volue of lov, coupon bond is f00 Face value of Jy. coupon bond i Je. Face volue of $7 coupon bod ts 9K 10° = go jo 3 Face value of the portfolio § = Joo — 8° = Qo. We can coleusate prince of the porfolio i ot fotout: Price of ley, coupom rk 98-42 Price of ty. coupon fs 98: #2 lo Price of 87. coubm ix oe eet = 78-946 There fore price of the peatfolro = $8:99— 78-976 =. G.9It The coupon payment of Hix portfolro, wit! be canced., therefore this porfolio Is Zeve-coupor. por folro. ° ' @V-bo fr Ss o Ft 8 3 le the so-yeor spol rate S,, mur saufy 10 Pe Says = bat (5. y° ‘ . 18 Qe 3 (Se) = Tae Yio = 2 pee" tie = (Cae) 71 Vittie@ -ONQO = Ih207, Scanned with CamScanner PPPPPPPPPPPPP PPP Hsgeeeaes ppppp e 2 COO OOOb CEC COE CCE ECK Cs 6 YVOVYOVKLE Forward Roles! - Forwerd rates are interest rates for ons to be borrowed between two daty i the future, but urdey tewms agreed Upon today. ColewaHor of foward rade using Spot vale: For simpuo'tf , we SO ui use the concept fo 2-year situation. Suppsx 4, ord $, ar pmow. If we teave 41 ta fwo yor account, then we row that money ust! be: (#42 )% (after favo yoo) Aifernadivey, we mught place the $1 1 a one. year account ane! See mae arrangements that the proceeds uve! be Jet for one ger starting one year from now. the toan accrue interest at a Pre arraingect rate oe f- the rote fs the forward vote for money to be dent in tis ea y Su oy de ° t 1. a ante, ° Wet Final amount at the end of two er igs = (on )4 Gf = (145 G+) We Pave tuo adternadive methods for Investing, al for az years. Fit retums = (45.4% omc! second retoms = (les, (1428) Scanned with CamScanner since both are available . (sy = (ian) O+8) ov +f = +a) at Ins i js (45. e IAS) Hemce forward vate 6 cktermineo! by the two spot rahe. B We can qustite the use of the eomparison principle Pere Hhresugl an arbitrage arpummont. Supper (1450)" G51) Ce J 3 either. (i+ #2)" ‘ Gos: G6) o (+s y'> Ors: G6). Coser: Sf fhosi) Sag) > Ort)? then orbitrage situation ust exists. In this situation one cam tafe a loan ui'a fest p+an ard can invest that nae ufo geeondl plan, and profit uw be multiple of (44, JO+£)— Cosy? this ovbitrage scheme covtd be carrie ow at om magnitude, and Fence, i tresry the arbitrageuy coulch make vers Jarge gums of money fom no trios cabitel. Gen: 9 (45) G44)

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